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Buy High Yield Bonds

High-yield bonds issued by foreign governments and foreign corporations will not be addressed within the scope of this booklet, which will primarily focus on high-yield bonds issued by U.S. corporations

buy high yield bonds

A variety of investors participate in the high-yield bond market. They include individuals who invest in high-yield bonds through direct ownership and/or through mutual funds; insurance companies; pension funds and other institutions.

Individual investors purchase individual high-yield bonds, often as part of a well-diversified investment portfolio. They also participate in this market through high-yield bond mutual funds.

High-yield bond investors require a tolerance for risk, along with the patience to weather periodic market downturns or unexpected events that negatively impact individual issues. In addition to risk tolerance, you need access to information or professional guidance in selecting and monitoring specific issues. Some techniques for reducing the special risks of this market are to:

Diversify across issuers and industry segments You should not put all your assets in one high-yield bond. Spreading money among several issuers and industries can help reduce the risk of price declines or defaults caused by industry-specific situations/circumstances.

Adjust portfolios over economic and market cycles One of the best times to own high-yield bonds is during the expansion phase of an economic cycle, when financial measures are increasing along with consumer confidence. The worst time is during a recession, when financial measures deteriorate and investors become increasingly anxious about holding higher risk securities.

However, due to their credit quality, which is lower than that of instruments like U.S. Treasury bonds or high-grade corporate bonds, high-yield bonds involve greater risk. You should evaluate whether the returns justify such incremental risks as:

Over the last decade, diversity has grown among issuers that tap the high-yield market. In the late 1980s, high-yield bonds were generated by a few participants and heavily used to finance merger and takeover activities. Today, the market has broadened to include many dealers and issuers with diverse needs. Issuers of high-yield bonds can be grouped into the following categories:

High-debt companies (which may be blue chip in size and revenues) leveraged with above-average debt loads that may cause concern among rating agencies. Companies refinancing debt sometimes turn to high-yield bonds to pay down bank lines of credit, retire older bonds or consolidate credit at attractive rates of interest. Companies also turn to the high-yield bond market for capital to fund acquisitions or buyouts, or to fend off hostile takeovers.

Leveraged buyouts (LBOs) create a special type of company that typically uses high-yield bonds to buy a public corporation from its shareholders, often for the benefit of a private investment group that may include senior managers. Some corporate assets or divisions may then be sold to pay down the debt.

Capital-intensive companies turn to the high-yield market when they are not able to finance all their capital needs through earnings or bank borrowings. For example, cable TV companies require large amounts of capital to acquire, expand or upgrade their systems.

High-yield bonds are corporate bonds issued by companies that have been given low credit ratings (BB+ or lower) by a credit-rating agency. They are not investment-grade bonds as they have a higher risk of defaulting. To offset that risk, high-yield bonds offer investors a much higher yield than better-rated bonds. Many investors choose to buy high-yield bonds through mutual funds to improve diversification and help to reduce volatility.

A corporate bond is a way for a company to raise money from investors to finance its business activities. Corporate bonds are primarily issued and traded on the over-the-counter (OTC) market. The minimum amount required to buy corporate bonds is typically large, up to $500,000.

Scammers may pose as a corporate entity, like a bank, and offer 'Treasury bonds'. This is a red flag that it's a scam. Corporate entities issue bonds in their own name. Only the Australian Government can issue Treasury bonds.

Credit rating agencies evaluate bond issuers and assign ratings. Issuers are rated on their ability to pay interest and principal as scheduled. Those issuers considered to have a greater risk of defaulting on interest or principal repayments are rated below investment grade (see Chart 1). These issuers must therefore pay higher coupons to attract investors to buy their bonds.

The high yield market has since evolved, and today, much high yield debt is used for general corporate purposes, such as financing capital needs or consolidating and paying down bank lines of credit. Mainly focused in the U.S. through the 1980s and 1990s, the high yield sector has since grown significantly around the globe in terms of issuance, outstanding securities and investor interest.

The high yield sector includes both originally-issued high yield bonds and the outstanding bonds of fallen angels, which can have a significant impact on the overall size of the market if large or numerous companies are downgraded to high yield status. Conversely, the sector can shrink when companies are upgraded out of the speculative grade market into the investment grade sector.

Compared to investment grade corporate and sovereign bonds, high yield bonds are more volatile with higher default risk among underlying issuers. In times of economic stress, defaults may spike, making the asset class more sensitive to the economic outlook than other sectors of the bond market. High yield bonds share attributes of both fixed income and equities, and can be used as part of a diversified portfolio allocation.

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Investors should consult their investment professional prior to making an investment decision.

BofA Merrill Lynch U.S. High Yield, BB-B Rated, Constrained Index tracks the performance of BB-B Rated US Dollar-denominated corporate bonds publicly issued in the US domestic market. Qualifying bonds are capitalization-weighted provided the total allocation to an individual issuer (defined by Bloomberg tickers) does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. Similarly, the face value of bonds of all other issuers that fall below the 2% cap are increased on a pro-rata basis. The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market. It is not possible to invest directly in an unmanaged index.

During times of economic stress, fallen angels are more prevalent. They typically underperform the debt of companies that get downgraded but remain within the investment-grade universe, in part because the buyer bases for investment-grade and high-yield bonds differ.

And when the economy is in a recovery phase, ratings upgrades tend to be more numerous, leading to a higher proportion of BB bonds migrating to investment grade. These rising stars typically see their spreads tighten and prices rise more than would be the case for an upgrade within the high-yield universe, in part because of their different buyer bases.

"The price dislocations that occur with bonds crossing the dividing line between investment grade and high yield present opportunities for active bond managers," said Michael Chang, a U.S.-based Vanguard senior portfolio manager. "Vanguard has a large, seasoned team of corporate credit analysts who work collaboratively across geographic regions to assess issuers' credit profiles and, more importantly for our clients in this segment, where they may be headed."

"Investors were concerned and cautious regarding the growth in outstanding BBB debt pre-COVID," said Michael Pollitt, a U.K.-based Vanguard senior credit analyst. "Given where we were in the credit cycle, there were fears that an economic slowdown would trigger a wave of downgrades to high yield that the junk bond market might not be able to absorb easily and forced selling by institutions and index funds with investment-grade-only mandates." 041b061a72


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