BREAKING DOWN ‘High-Yield Bond’
Also known as “junk bonds”.
Based on the two main credit rating agencies, high-yield bonds carry a rating below “BBB” from S to compensate for this risk, yields will typically be very high.
All “junk” connotations aside, high-yield bonds are widely held by investors worldwide, although most participate through the use of mutual funds or exchange-traded funds. The yield spread between investment grade and high-yield will fluctuate over time, depending on the state of the economy, as well as company and sector-specific events.
Generally, investors in high-yield bonds can expect at least 150 to 300 basis points greater yield compared to investment-grade bonds at any given time. Mutual funds provide a good way to gain exposure without the undue risk of investing in just one issuer’s junk bonds.
High-Yield Bond Market Performance
Recently, central banks around the world, such as the Federal Reserve, European Central Bank (ECB) and Bank of Japan, have taken measures to inject liquidity into their economies and keep credit readily available, thereby lowering the costs of borrowing and eating into the returns of lenders. As of February 2016, $9 trillion worth of sovereign bonds, or government debt, offered a yield between 0 and 1% and $7 trillion offered a negative yield, after accounting for expected inflation.
This would normally cause investors to look towards other markets to generate a higher rate of return, but high-yield bond markets have been volatile. Although the value of high-yield mutual funds rose from $100 billion in 2009 to $400 billion in 2014, the total value of the high-yield bond market fell from $1.41 trillion in April 2015 to $1.23 trillion in December 2015. This change is mostly the result of falling commodity prices, especially oil, that have hit the energy sector hard; energy bonds represent 14% of the high-yield market but 36% of the distressed high-yield market, as of 2015. Distressed debt is debt that offers a yield of at least 1,000 basis points over a Treasury bond with the same maturity. The selling off of high-yield debt led junk bond prices to fall by almost 5% in 2015; junk bond prices in the energy industry fell by 20%.