High-risk high-yield bonds a.k.a. speculative bonds or junk
bonds are those rated below BBB- by Standard & Poor's rating
agency. The default rate for junk bonds has been low at about
3.2% recently versus the historical norm of 4.5%. The outlook for
the default rate is favorable in the near term.
Junk bonds have boomed following the Fed's decision to
continue with its loose monetary policy with $85 billion in
monthly asset purchases. In fact, quantitative easing,
accompanied by rock-bottom interest rates, has been accused of
creating asset bubbles in places such as the treasury bond and
the junk bond markets.
With investors chasing higher yield in the wake of low returns
on other assets, high yield issuers raised a record quantum of
debt in 2012. Fund raising companies have frequently used the
proceeds to refinance higher interest-bearing loans. Some of the
money ended up with private equity firms, such as Bain Capital,
who borrow for leveraged buyouts and then burden the company with
debt. In any case, there is no doubt that the boom in junk bonds
has ensured access to capital markets for even those companies
with the lowest credit ratings.
The chase for yield has driven down the yield on junk bonds to
record lows. In fact, the interest in such bonds has been so
great that some mutual funds have even refused to take new
investors. Junk bond yields recently fell below 6% for the first
time (giving them about 500 basis points spread over U.S.
Treasury bills). From a historical perspective, junk bond issuers
have paid about 10% in interest charges. (It is noteworthy that
while yields may currently be low, spreads are nowhere near their
After several years of tidy returns, returns from junk bonds
came to over 15% in 2012. The sharpest appreciation has been in
the lowly CCC rated paper. With good returns in the period
following the financial crisis in 2008, market mavens wonder if
there is much room left for capital appreciation or whether these
bonds are to be held as a coupon play only.
Risks to the high yield market include a cyclical rotation
into equities, firmer interest rates or a weaker economy, which
would increase corporate default. Even without any recession,
there is risk in the sense that should earnings take off again,
then investors may bail out of debt to enter the stock market.
Furthermore, investors face potential losses in case of callable
T. Rowe Price High Yield Fund gave an annual return of 15.2%
in 2012 and a 3-year return of 10.8%. Prominent leveraged
plays in this fund include
Sprint Nextel Corp
CIT Group Inc.
The Putnam High Yield Advantage Fund gave an annual return of
15.1% in 2012 and a 3-year return of 10.4%. Noteworthy leveraged
plays in this fund include
HCA Holdings, Inc.
Besides high yield mutual funds, investors may also select
from the following two high yield bond
, both of which are well tracked, offer high liquidity and may be
considered to be a proxy for the junk bond market. The
iShares iBoxx $ High Yield Corporate Bd
SPDR Barclays High Yield Bond
) are well known junk bond ETFs.
CIT GROUP (CIT): Free Stock Analysis Report
HCA HOLDINGS (HCA): Free Stock Analysis
ISHARS-IBX HYCB (HYG): ETF Research Reports
SPDR-BC HY BD (JNK): ETF Research Reports
SPRINT NEXTEL (S): Free Stock Analysis Report
SLM CORP (SLM): Free Stock Analysis Report
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