In June we reminded our readers that, while investment grade corporate bonds are a worthy portfolio diversifier, high-yield or “junk” bonds are far more volatile and therefore unsuitable for most household investors. Junk bonds are loans to firms with dubious credit quality (these bonds are graded Ba or lower by Moody’s Investor’s Service, or BB+ or lower by Standard & Poor’s).
Because they bear a higher risk of default junk bonds have traditionally offered higher yields than investment-grade bonds. In light of near-zero percent short-term interest rates that have prevailed for the past seven years, many investors have thrown caution to the wind by reaching for these higher yields.
Those who took the plunge were jolted in early December when a junk bond mutual fund, Third Avenue Focused Credit, halted investor redemptions in order to facilitate an orderly sale of its assets. The junk bond universe is dominated by debt issued by energy-related firms, and falling energy prices sparked a rout that quickly spread to other sectors of the high-yield universe. Massive bond defaults have thus far been averted as many energy firms have hedged their exposure to the oil price, but the episode serves as a stark reminder of how quickly and severely credit crises can imperil a fixed income portfolio designed for stability.
These circumstances warrant a review of the important distinctions between investment grade and high-yield corporate bonds.
Also In This Issue
The AIER/AIS Collaborative Research Effort
Don’t Pay For Part Performance
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Recommended Investment Vehicles
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