Junk Bond Market Heating Up, But Are Investors Taking on Too Much Risk?

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Investors are flocking to junk bonds as they work to bolster their portfolios against market volatility.

Companies with dubious credit ratings issue junk bonds, which are also more affectionately known as high- yield bonds. Such borrowers pay elevated interest rates because of the inherent risk they pose, and they are a gamble for investors, particularly amid ongoing unease in the global economic landscape.

Still, high-yield bonds have the potential to earn their owners a significant payback, but they are also subject to the whims of market conditions. The higher the bond 's yield, the bigger the potential payback - though junk bonds associated with the riskiest companies carry the largest possible return on investment .

At the height of the financial crisis, junk bond yields were 22.3 percentage points above Treasuries. That figure has fallen over the past four years, but they are still delivering yields nearly 5 percentage points higher than government-backed securities. Whether investors should consider strategically adding junk bonds to their portfolios depends on how much risk they are comfortable taking on.

Retail investors have shown their appetite for risk is growing, as they have poured more than $11.8 billion in junk bond mutual funds this year, according to data from the research firm Lipper. Mutual fund managers are also ramping up their purchases of junk bonds , The Wall Street Journal reports.

The junk bond market is only beginning to heat up, but a growing number of investors are eyeing the 4.74 percent interest rate they have returned thus far this year as a way to diversify their holdings. That yield is still less than the 8.6 percent uptick logged by the Standard & Poor's 500- stock index since the onset of 2012, but junk bonds returned 4.98 percent to investors last year while the S&P 500 delivered only 2.1 percent growth.

Bullish investors such as MFS Investment Management chief investment strategist Jim Swanson contend that junk bonds are poised to rise.

"High yield isn't near its lowest spread and is still above its long-term average," he told the WSJ. "All that has to happen for us to make money is for spreads to get tighter."

Junk bonds have gained in popularity as an investment tool because companies have had the past three years to restructure their debt and overhaul their business models amid record low interest rates. While equities are still returning higher yields since the beginning of this year, some investors and mutual funds have increased their high-yield holdings in an effort to prepare for potential shocks that could hit global stock exchanges.

 



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: News Headlines , Bonds , Mutual Funds

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Michael Bordieri


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