What are High Yield Bonds?
High yield bonds (sometimes referred to as “junk bonds”) are bonds issued by high risk companies that offer investors higher returns than investment grade bonds. But, along with higher returns comes a higher risk factor.
Advantages of High Yield Bonds
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Higher Yields: One of the main advantages of high yield bonds is the potential for higher yields than with traditional, investment grade bonds (which tend to offer lower yield payouts). High yield bonds can offer returns of up to 8%.
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Potentially Less Volatile: High yield bonds are often seen as a way to diversify a portfolio and thus reduce volatility. High yield bonds are not correlated to the stock market, meaning that they may be less likely to significantly fluctuate in price like stocks.
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Access to Different Markets: High yield bonds can provide investors with access to markets that may otherwise be inaccessible due to their higher risk. For example, some emerging markets may offer attractive yields due to their higher risk, but can be difficult for retail investors to access. High yield bonds can provide an easy way for investors to get exposure to those markets.
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Inflation Protection: High yield bonds can provide investors with an inflation hedge. As inflation rises, the price of these bonds can rise as well providing a hedge against an increase in consumer prices.
Disadvantages of High Yield Bonds
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Lower Quality Companies: High yield bonds are issued by companies that are considered to be of lower quality and that typically have a credit rating below investment grade (BB or below). This means that these companies may have some underlying financial issues that can lead to default.
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Lack of Liquidity: High yield bonds tend to be less liquid than other types of bonds, making them difficult to sell in the secondary market. As a result, investors may have to accept lower prices than they would expect in order to quickly liquidate their holdings.
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Higher Risk of Default: As a result of the lower quality companies that issue high yield bonds, investors face a greater risk of default. The higher risk of default is also due to the fact that these companies may have higher levels of debt that could make it difficult for them to meet their obligations.
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Interest Rate Risk: High yield bonds also carry a greater risk of interest rate fluctuations. When interest rates rise significantly, the prices of these bonds can fall. This can mean lower returns for investors who hold on to the bonds in their portfolio.
High yield bonds can be a great way for investors to access higher yields and potentially diversify their portfolios. But, it is important to understand the risks involved with these types of investments and to ensure that they are suitable for an investor’s risk profile. Investors should always consult with a financial advisor to ensure that these types of investments are right for them.
