Financial Focus: High-yield bonds
By Craig Elder on May 4, 2019.
In the age of low interest rates, investors are not receiving “cash flow” at a level they were used to in the past. This has led to looking for investments that offer a higher cash flow to meet their needs. One of the more common fixed income products that investors are turning to are high yield bonds. A high yield (or sometimes termed “junk”) bond is essentially the same as a regular bond; it pays a coupon, has a set maturity date and will pay back its principal upon that date, however its credit quality is non-investment grade. Bonds can be classified as below investment grade or sub-investment grade/high yield. Investment grade bonds have ratings of AAA to BBB and are issued by low to medium risk lenders. Alternatively, speculative grade bonds are issued by medium to high-risk lenders and offer higher yields to compensate investors for the additional risk. In fact, high yield bonds are more similar to a conservative equity security than a traditional government bond, as their capital returns can be quite substantial. High yield bonds can be further compartmentalized into two categories: Fallen Angels and Rising Stars. Fallen Angels are bonds that were once investment grade but have seen their rating reduced to sub investment grade, while Rising Stars are bonds that are improving in credit quality. Sub-investment grade bonds’ higher potential price volatility and default risk suggest that high yield bonds should be viewed in terms of potential total return, rather than absolute yield to maturity. However, although high yield bonds appear attractive, there are a number of risks that should be assessed and made known to an investor before choosing to invest. Those risks are default risk, downgrade risk, transparency risk and liquidity risk. In any case too much of one thing is never good. Chasing yield or investments that produce high cash flow may increase investment risk.Using high yield bonds as part of your bond exposure of your overall portfolio diversification strategy may make sense. Contact us to further discuss high yield bonds and how other fixed income solutions can work for your portfolio and cash flow needs. A. Craig Elder, CFP, FMA, CIM, FCSI, is a Vice-President, Portfolio Manager and Wealth Advisor with RBC Dominion Securities Inc. in Medicine Hat. RBC Dominion Securities is a member of the Canadian Investor Protection Fund. This column is for information purposes only. Please consult with a professional advisor before taking any action based on information in this column. For more information on this and other financial strategies, contact Craig at 403-504-2723. 7-6
