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The case for high-yield bond investing.
(Note: related companies are at base of the story and all the sources listed in the "Balanced" section)
High-yield bonds, once thought of as appropriate only for sophisticated investors or bond investment houses, have become more commonplace in recent years with the spread of high-yield bond ETFs. Through these ETFs, individual investors can have a diversified exposure to an investment class with characteristics of both bonds and equities. But investing in high-yield bonds is not for the faint of heart. High-yield bonds performed poorly in 2018 causing the spread between junk bonds and treasuries to widen. This potential for higher return begs the question:
Is now a good time to invest in high-yield bonds?
Winning the popularity contest. Money is flowing into high-yield bonds and the growing popularity could support prices. Carolina Wilson and Reade Pickert report that investment houses such as BlackRock Inc. and State Street Corp. reported record levels of funds flowing into high-yield bond ETFs in recent months.
High-yield bonds provide diversification. Nuveen makes the case that high-yield bonds are negatively correlated with treasury bonds and generate positive return even in a rising interest rate environment. This argument makes the case for high-yield bonds as a separate investment classification within a well-diversified portfolio.
High-yield bonds provide favorable returns without added volatility. A study by Shroeder indicates that high-yield bonds provide return similar to equity without the volatility seen in equity investments.
Junk pollutes the bond market. A CNBC study indicates that bonds with a BBB rating represent 50% of all investment grade bonds, up from 38% ten years ago. Companies have been leveraging balance sheets to make investments or buy back equity, pushing their ratings to the verge of junk status. This leaves little room to react in the case of unforeseen negative events.
Rob Isbitts, a senior Forbes contributor, believes many BBB rated bonds are simply junk bonds masquerading as investment grade. He points to a large number of BBB bonds coming due in the next few years, which could create an oversupply of offerings when the bonds are refinanced.
Other pundits point to economic concerns that could negatively affect high-yield bonds. Skybridge Capital has taken a large short position on high-yield bonds specifically pointing to developments in China as a major risk for investors.
When in doubt, diversify. High-yield bond performance will most likely be a function of economic and political factors that also have an impact on equity and bond markets. Predicting market movements is difficult and often futile. A strategy of full investment with a portion of the investment allocated to high-yield bond funds seems a prudent investment.
Junk Bond ETFs Add Cash as Panic Fades After High-Yield Rout, Carolina Wilson and Reade Pickert, Bloomberg, January 8, 2019
The Enduring Case for High-Yield Bonds, Nuveen, January 14, 2019
The Case For High Yield, Martha Metcalf and Julie Mandell, Schroders, January 14, 2019
Things Getting Stormier For Investment Grade Bonds, Andrew Osterland, CNBC, October 8, 2018
Complacency Defined: The Case of the High Yield Bond Market, Rob Isbitts, Forbes, January 8, 2019
Skybridge Capital’s Big Short Is High Yield Bonds, Mary Childs, Barron’s, November 19, 2018