Risks associated with high yield bonds

Most leading investors in bond market recommend flexible buying and diversification in different types of bonds.   These flexible bonds are the one where the interest spectrum is fixed and one can adjust the rate to get better portfolio. The diversification can be achieved in different investment grade, government-backed, long or short term and other types of capitals in different markets. Currently, the low rates pose threat to investors while, the high risk bonds can provide better returns.

Bonds are rated high or low yield depending upon the principle and the rate of returns promised by the company.   High yield or fallen angels are investment grade bonds which were first sold in 1980s, mainly, for acquisitions and mergers (or buyouts). The risk is high in these bonds which are highly influenced by market volatility and the risks are very high during recession.  These bonds offer higher returns as compared to government bonds, and yield may even depends on economic climate or downturns.  Some of these bonds provide double digit returns but the risks are even higher. In 2009, the rate of return fluctuated from 5 to 0.5 per cent. Most of these bonds have low –term maturation, although, some are offered for five to ten years as well.

Globally, highest number of high yield bonds is offered in US markets. In the US, tax reforms are being made to introduce tax deductions from earnings of the high yield bonds. The government announced tax deductions but the implementation will happen in 2019. In the UK, central banks are preparing to increase interest rates as the bonds with low rates are less attractive leading to decrease in prices in markets.

The duration of bond also determines the rate and returns. The length of time for maturity and the sensitivity to market volatility as well as the change in rates is measured by rating agencies. The bond with duration of 3 years – means the value reduces 3 per cent for increase of 1 per cent rate in one year. Some of the popular high yield bonds are Twenty Four Dynamic (and Twenty Four Global Unconstrained Bond), Royal London,   Hermes Multistrategy and M&G strategic. TwentyFour Dynamic & Royal London is invested in the UK, and Hermes Multistrategy is famous in North America. The rate of returns can be in the range 3 to 5 per cent, and some of these bonds are offered with protection, where the rates may rise even if the shares are falling.

Most of these bonds are released by companies that are financially less secure.  There are many related risks of investing in such bonds where the issuing companies can show greater financial issues. Trouble in high yield bond can be identified by examining the credit risk of the borrower, its structural quality and debt issue. Experts believe the market bubbles are created by such bonds E.g. in 2010, the US Shale energy boom led to increased investment in these bonds but those who bought it at peak prices, suffered great losses. Currently, only 11 per cent of market securities are CCC rated as compared to 33 per cent in 2007.  

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