One commonly used indicator of risk when investors are choosing which bonds to buy is credit rating.  3 major credit ratings agencies – S&P, Fitch and Moody’s – use a standardised set of rules to assign each bond a rating that indicates how likely you are to get your initial investment and returns in full and on time.

Bonds with a credit rating from AAA to BB are called investment-grade bonds. These bonds are at the lower risk end of the spectrum.  At the other end are bonds rated BB to D which are called high-yield bonds (or junk bonds). These bonds give a better rate of return and the trade- off for this is that they are also riskier.  Make sure you do some research into the risks and rewards of the bonds before investing your money.

Junk Bonds
Although high yield bonds may seem off putting, due to their lower credit rating, there is a vast offering and many market of buyers and sellers in this category. In fact some of the biggest, well established Fortune 500 companies have in the past and continue to issue junk grade bonds.

In a low interest rate environment there are so few lucrative options for our money – money in a savings account or investment grade bonds will generate very little return. In addition, in a low interest rate environment, typically, lending to businesses will be in smaller volumes. This means businesses profits will not be as good and if you invest in equities your returns may not be high either. In these conditions junk bonds may be appealing as they offer a high rate of return when almost no other investment does.  To some investors, if given the opportunity, investing in Fortune 500 companies with a high rate of return seems like a clear choice for their money – however the majority of investors still hesitate and beware the junk bond risks.

Junk Bonds – Beware!

This is most likely because of historical price behaviour of junk bonds. Junk bond prices can be very volatile – this means the price can swing up and down a lot. Some investors find this kind of price behaviour unpleasant – one day you’re making lots of money on your investment, the next you’ve lost a lot of money.  The other concern is that some companies issue junk bonds and they are not committed to returning initial investments from the outset – this is called market abuse.

You might buy a junk bond and that company may have already decided in advance that they would use your investment and declare bankruptcy before it is time to return your initial investment. You could lose all of your money with a higher probability with high yield bonds.  In fact many Wall Street professionals will argue that the negative outlook on high yield bonds persists because of market abuse and questionable practices of financial and business professionals.

Why Invest in High Yield Bonds?

However, in some cases, junk bonds do not necessarily deserve the negative reputation that they have accumulated. In fact, adding high-yield bonds to a mixed portfolio may reduce total portfolio risk. This is through the benefits of diversification – all your eggs are not in one basket.  The returns on high-yield bonds do not move exactly in line with either investment-grade bonds or stocks – we say they are not strongly “correlated”.

This low correlation means adding high-yield bonds to portfolio can be a good way to reduce risk and boost returns. Another benefit is that because the yields on junk bonds are higher than investment-grade one they are not as vulnerable to interest rate shifts.  Also, if you are seeking higher yield for your fixed-income portfolio, high-yield bonds can be a sensible choice as they have typically produced better returns than government bonds and high rated corporate bond issues.

There are genuine situations in which good companies experience some phases of financial difficult – a one off bad year for profits can lead to a company’s bond ratings to be downgraded to a level lower than investment grade. In this situation high yield bonds can be a good opportunity for investment.

Emerging Markets

Another option investors have when looking for high yield investments in a low interest rate environment is emerging markets. Investing in emerging markets stocks and bonds is cheaper than when looking at developed nation’s securities. This is because you are exposed to a much smaller market.  Emerging markets currently account for a big portion of high-yield markets on a global scale.  Although emerging markets can appear to offer high rates of return on your money this comes with a higher risk to your money.

Investing in these regions can expose you to a wide range of unexpected risks – the government could collapse due to political vulnerabilities, the company could go bankrupt at a higher level of probability. Corruption, instability, poor infrastructure and many more conditions of doing business in emerging market regions lead to risk trickling through the economy, through the banking and financial sector and can impact your investments negatively.

Bottom Line

The ability to give you high levels of income return and the ability to reduce overall portfolio risk are good reasons to consider high-yield investments. Before investing in high-yield bonds, you should make sure that you are aware of the risks.  Do some research on financial advisory, and you will find the right investment for you and your circumstances.
If you are new to bonds, read more on Bonds 101 and How to Get Started on Bonds.

 

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Founder @ The New Savvy
Anna Haotanto is the Advisor (former CEO) of The New Savvy. She is currently the COO of ABZD Capital and the CMO of Gourmet Food Holdings, an investment firm focusing on opportunities in the global F&B industry. She is part of the founding committee of the Singapore FinTech Association and heads the Women In FinTech and Partnership Committee. Anna is the President of the Singapore Management University Women Alumni. Anna invests and sits on the board of a few startups. Anna is also part of the Singapore Chinese Chamber of Commerce & Industry Career Women’s Group executive committee. Anna’s story is featured on Millionaire Minds on Channel NewsAsia. She hosts TV shows and events, namely for Channel NewsAsia’s “The Millennial Investor” and “Challenge Tomorrow”, a FinTech documentary. Anna was awarded “Her Times Youth Award” at the Rising50 Women Empowerment Gala, organised by the Indonesian Embassy of Singapore. The award was presented by His Excellency Ngurah Swajaya. She was also awarded Founder of the Year for ASEAN Rice Bowl Startup Awards. She was also awarded the Women Empowerment Award by the Asian Business & Social Forum. Anna has been awarded LinkedIn Power Profiles for founders (2018, 2017), Tatler Gen T, The Peak’s Trailblazers under 40 and a nominee for the Women of The Future award by Aviva

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