High Yield Bonds turn out to be bonds that possess a lower credit rating and higher yield than those corporate, municipal, and sovereign government bonds which are of investment grade. Thanks to the greater risk of them defaulting, such bonds yield a higher return than the bonds which are qualified investment grade issues. Those companies that issue high yielding debt are usually capital intensive companies and startup firms that already possess higher debt ratios. Investors often refer to such bonds as junk bonds.
The two principal corporate rating credit agencies determine the breakdown of what qualifies as a High Yield Bond and what does not. When Moody’s rates a bond with lower than a “Baa” rating, or Standard and Poor’s (S&P) rates then with an under “BBB” rating, then they become known as junk bonds. At the same time, all of those bonds which enjoy higher ratings than these (or the same rating at least) investors will consider to be investment grade. There are credit ratings that cover such categories as presently in default, or “D.” Those kinds of bonds holding “C” ratings and below also have high probabilities for defaulting. In order to compensate the investors who take them on for the significant risks they run of not receiving either their original principal back or accrued interest payments by the maturity date, the yields must be offered at extremely high interest rates.
Despite the negative label of “junk bond,” these High Yield Bonds remain popular and heavily bought by global investors. The majority of these investors choose to diversify for safety sake by utilizing either a junk bond ETF exchange traded fund or a High Yield Bonds mutual fund. The spread between the yields on the higher yielding and investment grade types of bonds constantly fluctuates on the markets. The at the time condition of the global and national economies impacts this. Industry-specific and individual corporate events also play a part in the differences between the various kinds of bonds’ interest rates.
In general though, High Yield Bonds’ investors can count on receiving a good 150 to 300 basis points more in yield as measured against the investment quality bonds in any particular time frame. This is why mutual funds and ETFs make imminent sense as an effective means of gaining exposure to the greater yields without taking on the unnecessary risk of a single issuer’s bonds defaulting and costing the investors all or most of their original investing principal.
In the last few years, various central bankers throughout the globe have decided to inject enormous amounts of liquidity into their individual economies so that credit will remain cheaply and easily available. This includes the European Central Bank, the U.S. Federal Reserve, and the Bank of Japan. It has created the side effect of causing borrowing costs to drop and lenders to experience significantly lower returns.
By February of 2016, an incredible $9 trillion in sovereign government debt bonds provided yields of only from zero percent to one percent. Seven trillion of the sovereign bonds delivered negative real yields once adjusted for anticipated levels of inflation. It means that holding such bonds cost investors money, or provided them a real losing return.
In typical economic environments, this would drive intelligent investors to competing markets that provide better return rates. Higher yield bond markets have stayed volatile though. Distressed debts which pay minimally a yield higher than 1,000 basis points greater than a comparably maturing Treasury bond were notably affected. Energy company high yielding debt bond prices collapsed by approximately 20 percent in 2015 as a consequence of the problems in the energy sector which resulted from plummeting energy prices.