For a long time, high yield bonds carried a reputation as purely speculative junk. That label ignores how much this market has matured, and how much it can add when used with care. For financial advisors who are building income-focused portfolios, high yield bonds deserve a fresh look.
In this article, Wealth Professional explains what high yield bonds are, how they work, how they compare with other bonds available to your clients in Canada. We've also rounded up the latest news on high yield bonds for you at the bottom of this article.
High yield bonds are corporate bonds issued by companies with lower credit ratings. Rating agencies such as S&P and Moody's classify them below investment grade.
On one side you have investment grade corporate bonds, issued by companies that rating agencies see as relatively stable and less likely to default. On the other side you have high yield issues, which compensate investors with more income in exchange for more credit risk.
Within high yield itself, quality varies. Many issuers are not distressed at all. In fact, more than half of the global high yield universe holds ratings in the BB area. This is just one step below investment grade.
These companies might have sound business models yet carry higher debt loads or operate in sectors with earnings that fluctuate. Others sit lower on the rating scale and carry far more risk.
Watch this video to learn more about high yield bonds:
Do you have clients who are retirees? If they are considering high yield bonds to boost income, ground the discussion in the trade-offs involved in chasing a six percent yield on a retirement portfolio.
Recent years have seen a shift in global bond markets. After a long stretch of very low interest rates, central banks raised policy rates aggressively to control inflation. This adjustment hurt many longer duration fixed income assets, but it also brought income back into the fixed income universe.
High yield bonds in particular offer:
Historically, high yield bond returns have shown a close relationship with equity returns, but with lower volatility in many periods. For your clients who want equity-like income potential but prefer a fixed income instrument, that profile can be appealing.
For financial advisors, the question of the best bonds is really a question about matching bond types to your clients' goals, risk tolerance, and time horizon. There is no single bond category that fits every situation.
Instead, it helps to understand how different segments behave, then decide what mix works inside a diversified portfolio:
Government bonds from stable, developed countries such as Canada and the United States are often seen as lower risk. The chance of default is low, and they provide a steady stream of interest payments. They are especially useful for:
The trade-off is that their yields can be lower than those on corporate bonds. For income-focused clients, government bonds alone might not provide the level of cash flow they expect, especially after inflation.
Investment grade corporate bonds are issued by companies that rating agencies view as financially solid and less likely to default. They usually offer higher yields than government bonds from stable countries, in exchange for taking on corporate credit risk.
These bonds can suit your clients who want:
However, investment grade bonds often carry longer duration than high yield bonds. This can increase sensitivity to interest rate movements, which is important in an environment where rates can change quickly.
As we've discussed earlier, high yield bonds occupy a different place. They carry more default risk than investment grade corporate or government bonds, but they compensate investors with higher yields. Historically, they have paid more than both investment grade corporate bonds and government bonds.
For client portfolios, high yield bonds can serve as an income booster for those who want stronger cash flow. These bonds can also be a complement to equities, since high yield bonds have often behaved more in line with corporate fundamentals than interest rate moves.
Many investors access high yield bonds through mutual funds or exchange-traded funds (ETFs). These pooled vehicles can help reduce issuer specific risk compared with holding a few individual bonds.
At the same time, funds can still experience strong price swings. In turn, they require the same level of risk discussion you would have when buying high yield bonds directly.
High yield bonds offer attractive yields, but they also come with real risks that financial advisors must explain to their clients:
The central risk in high yield bonds is default. Issuers are companies that rating agencies see as more likely to experience financial stress. Some carry high debt levels. Others have uncertain business prospects or cyclical earnings.
If a company cannot meet its interest or principal payments, it can default. In such a case, holders of its high yield bonds might recover only a portion of their investment or, in some instances, nothing at all. This is why rating agencies assign those lower ratings and why these bonds need to offer more income to attract investors.
In high yield markets, defaults are not rare. Over time, some issuers will fail. At the same time, the default environment changes with the economic cycle and with corporate fundamentals. When balance sheets are improving and corporate health is stronger, default rates can stay at manageable levels.
For your clients, the impact of default risk depends on how they access the market. A single bond default can be very painful if they hold only a few issues. In a diversified fund or ETF, the impact of any one default is far smaller, though it still affects overall returns.
Even though high yield bonds sit inside the fixed income category, they can experience price swings similar to equities. Their prices react to changes in credit spreads and economic expectations.
For example, during a period of broad risk aversion, investors often demand higher compensation for credit risk. Spreads widen and high yield bond prices fall, even if the individual issuers continue to make their payments.
This volatility can surprise your clients who expect all bonds to behave like short-term government issues. High yield bonds do provide regular income, but their market value can move up and down quite sharply, especially during stressed markets.
Another factor to consider is liquidity. In calm conditions, many high yield bonds trade without much difficulty. In periods of market instability, trading volumes can dry up, and bid-ask spreads can widen.
For those who need to exit a position quickly during those times, this can mean accepting a lower price than they expect. High yield bond funds and ETFs can also experience this effect if outflows rise suddenly and managers must then sell into a weak market.
High yield issuers often depend on capital markets to refinance their debt as it comes due. When interest rates move higher and spreads widen, some companies can struggle to roll over existing bonds at acceptable costs.
If an issuer cannot refinance on reasonable terms, pressure on its financial position increases. In the worst case, this can contribute to default. Even before that point, rising refinancing costs can weigh on profitability and credit metrics, which in turn affects bond prices.
Conversations about high yield bonds work best when they start with education. Your clients are often familiar with the idea that more return usually requires more risk. High yield bonds are one good example. It can help to frame high yield bonds as:
During periods of moderate economic growth, high yield bonds have often delivered attractive risk adjusted returns, helped by their income cushion. During deep downturns, they have been more vulnerable. This is why position sizing and diversification are so important.
A top-performing financial advisor in Canada can incorporate carefully selected high yield bonds into diversified client portfolios to enhance income potential. They can do this while actively managing the risks mentioned above.
High yield bonds are no longer a niche corner of the market that only aggressive investors consider. The segment has matured, with stronger fundamentals across many issuers and a higher share of bonds in the upper tier of non-investment grade ratings. At the same time, yields today are attractive by historical standards.
For financial advisors who are helping clients balance income needs with risk control, high yield bonds can serve a critical role. They offer elevated income and a return profile that links closely to corporate performance rather than interest rates alone.
These advantages come with real downsides. Defaults, volatility, liquidity pressure, refinancing challenges, and sensitivity to recessions are all part of the high yield story.
The right response is to use diversification to reflect your clients' objectives and comfort with risk. Used in this way, high yield bonds can enhance an investor's overall fixed income mix.
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