Give junk bonds a chance?

When we think of creative investing, bonds aren’t exactly where you’d expect to turn in most cases. However, bonds are often more interesting than you think, which comes from the diversity found in their many flavors.

One of these unique flavors is high yield bonds, often referred to as “junk bonds” because of their high risk. And investors have flocked there lately despite their stigma.

Junk bonds got their name because of their high risk of default. Unlike government bonds, junk bonds are issued by companies and often offer a much higher yield to compensate for the extra risk you take on.

The trend

  • Follow the money: Monthly net flows into high-yield bonds were negative all year, but suddenly increased in July, bringing in $6.8 billion net. The big funds led the way and this sentiment spilled over into the junk bond market.

  • Why now? The corporate bond market saw a rapid rise in yields this summer towards the end of the second quarter, and they were up more than 92% from a year ago, a key factor in attracting big money fees from both active funds and investors. Elsewhere and more generally, these investors are also believed to have reinvested in these bonds due to a sudden increase in sentiment towards the markets and the economy. With this in mind, it is important to remember that there is no single reason for a trend, but once something has gained momentum, investors will jump on it.

Things to know

  • Why the term trash? When you see a stock with a ridiculously high dividend yield, you know something is up, because dividends that are too high are inherently unsustainable, not to mention those that are typically increased to offset the risks associated with owning the stock. ‘stock. The same goes for high yield bonds. They are called “junk bonds” because although they have a high yield, their credit rating is often low, and the risk of default is reflected therein.
  • Everything in moderation: Unusual investments with higher risk like junk bonds probably shouldn’t be considered the main food group in any portfolio. Instead, they should be treated as a side dish that adds flavor if they work in your favor, and general guidelines would suggest no more than a 3-5% allowance.
  • Also watch out for rising rates: The Fed is accelerating these rate hikes, which has two main implications for junk bonds. On the one hand, it drives up US Treasury yields. This narrows the spread between coupon rates on this risk-free asset and junk bonds, making risk less attractive. In addition, higher interest rates mean that companies issuing these bonds could have a harder time repaying their debts, especially those that may need to refinance on maturing bonds.

Follow this related lesson on this topic and earn Dibs 🟡 while you’re at it:

Comments are closed.