Think high yield equals high risk? Jim Keenan, Head of the Leveraged Finance Group at BlackRock, sees greater risk in not investing in this high income-potential asset class in today's low-rate, slow-growth environment.
Why invest in high yield bonds?
High yield occupies a sweet spot between traditional fixed income and equities-greater yield potential than investment-grade bonds, and historically comparable returns and lower volatility than equities.
Why not higher-quality bonds?
Compared to Treasuries and other higher-quality bonds, high yield has always offered appreciably higher yields, but this is especially important in the current low-rate environment. The traditional "safe-haven" bonds may very well offer negative returns after inflation. They also are more exposed to price loss when rates do eventually rise because of their generally longer duration. High yield's shorter duration (generally 4 to 5 years) means It is less sensitive to interest rate risk.
What about credit risk?
Yes, non-investment-grade debt securities have been subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories. However, the high yield market has evolved considerably in recent years. Company cash flow is up and leverage is down. Default rates are low, thanks in part to corporate strength, and yields are attractive. We believe the risk/reward tradeoff in high yield is extremely compelling.
Why is now the time for high yield?
Investors need income today, and the traditional sources are coming up short. While spreads are no longer at their widest, high yield still offers meaningful income enhancement over comparable-duration Treasuries. High yield would certainly lose value in the case of a systemic shock or economic downturn, but with yields as high as they are on a relative basis and default rates low and likely to stay there near-term, we believe investors are well compensated for the risk they are assuming in the asset class today.
Investment involves risks. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. The two main risks related to fixed income investing are interest-rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable. Investments in non-investment-grade debt securities (high yield or "junk" bonds) may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories.
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