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 Canaccord Genuity Corp.

High-Yield Bond Funds

Jarrett McKay - Jul 11, 2016
A high-yield bond, or "junk bond" is a bond that is issued by a corporation with a non-investment-grade credit rating (below BBB as rated by Standard and Poor's or Baa as rated by Moody's). Corporations with weak balance sheets, such as those with hi

A high-yield bond, or "junk bond" is a bond that is issued by a corporation with a non-investment-grade credit rating (below BBB as rated by Standard and Poor's or Baa as rated by Moody's). Corporations with weak balance sheets, such as those with high amounts of debt or uncertain prospects, are often downgraded by credit-rating agencies given that the chance of default in paying back debt, or bankruptcy, is higher than those corporations with strong balance sheets. As a result, high-yield bonds typically have higher yields than investment-grade corporate bonds.

 

High-yield bonds are not correlated with government yields. In early recovery cycles, as government yields rise, high-yield bond prices have been shown to recover as an improving economy generally signals a decreased risk of credit defaults, while government bond prices have declined.
A high-yield bond fund manages a portfolio of individual high-yield bonds. This may be a suitable addition as you look to another asset class to diversify your portfolio.

 

What are the advantages associated with high-yield bond funds?


• Diversification - A high-yield bond fund tries to ensure that a default, and associated losses, of any one bond will be offset by the remainder of the high-yield bonds in the fund. Within a portfolio, high-yield bonds typically have low correlation to other fixed income classes which may enhance portfolio diversification.


• Priority Ranking - High-yield bond holders usually rank second to senior lenders, such as banks, but ahead of all equity holders in the unlikely event that the issuer is liquidated.


• Access to High-Yield Bonds - Many funds have greater access to the market for high yield bonds which are often issued in private placements and initially unavailable to the retail market.

 

What are the disadvantages?


One of the greatest disadvantages of investing in high-yield bonds is the risk of default. It may be difficult to assess the default rates for high-yield funds because the manager may have the opportunity to dump bonds before they actually default and replace them with new bonds. However, the fund's average credit quality may be used as an indicator, with a lower average credit rating potentially representing a higher risk of default. Similar to owning individual high-yield bonds, there is also the risk that the value of certain high-yield bonds may reduce the bond fund’s value, if a particular company's financial position deteriorates and the credit rating is downgraded.


Seek Advice


Investors interested in this asset class need to consider both the benefits and risks when deciding to make a purchase decision. Please don't hesitate to contact us if you would like to discuss whether a high-yield bond fund may make sense for inclusion in your portfolio.

 

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