Why high-yield bonds may not be worth it

There might be hidden risks when it comes to these fixed-income instruments

Why high-yield bonds may not be worth it
While low interest rates currently make high-yield corporate debt attractive to investors, a group of analysts see certain risks that could erode returns from these vehicles.

“The yield on the Bloomberg Barclays global high-yield corporate bond index stands at just over 5% … But what really matters is the extra yield—or spread—that investors pick up versus other, safer asset classes like government bonds,” said Richard Barley of the Wall Street Journal in a recent column.

High-yield corporate bonds seem to have a healthy premium over other instruments such as the five-year US Treasury, which yields 1.8%. But strategists at Prudential Portfolio Management Group, part of Prudential PLC in the UK, consider risks of default from some high-yield companies, even if the economy is fine. These translate into long-run losses that whittle away at returns.

They also deduct the spread available on safer investment-grade corporate bonds. Their reasoning, according to Barley, is that investors will prefer to buy less risky securities assuming that let them achieve the same yield pickup.

“On that basis, the risk premia on high-yield bonds in the US and Europe were negative in June, PPMG calculates,” Barley said. “The extra yield wasn’t enough to compensate investors for the risk of owning them over time.”

He said the last time this happened was in 2014, after which there was a selloff that accelerated in 2015 as the oil-price plunge hit energy companies, notably those in the US.

“There may not be an immediate catalyst for the market to fall now,” Barley said. “But for investors buying high-yield bonds, the risk-reward balance doesn’t look encouraging.”

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