When you hear of junk bonds, you instantly think of something that may be a worthless investment. However, a few decades back, this was a rightfully deserved and well-earned name for high-yield bonds. These bonds are issued by businesses that are non-investment-grade and can be a valuable investment for some. Just because a bond issuer is not ranked high, it does not necessarily mean that the bond will tank. In many instances, these bonds give you greater returns as compared to their investment-grade counterparts. Here are a few benefits of high-yield bonds:
Higher expected returns
High-yield bonds assure a higher return over investment-grade bonds in almost every long holding period. Take iShares iBoxx $ High Yield Corporate Bond ETF as an example. From the commencement in 2010 to the end of 2019, these high-yield bonds had a total average annual return of 6.44 percent. In the same period, the iShares iBoxx $ Investment Grade Corporate Bond ETF had a total average annual return of 5.93 percent. It is entirely in tandem with the modern portfolio theory that states the investors bearing high risk are mostly compensated with higher returns.
During liquidation, bondholders are paid out before stockholders
At times, you know that a business is risky, but you foresee greater returns and invest in it. However, unfortunately, the business tanks. So, what happens to your investment as a bondholder? In this case, the business will go into asset liquidation, and you will be paid before the stockholders. Typically speaking, a defaulting company implies that their issued stocks and bonds are worthless. However, since the bondholders are paid out before the shareholders, there is a good chance that their investment is safe. So, conclusively, despite being called junk bonds, high-yield bonds are safer than stocks in many cases.
Consistent yield
Almost every junk bond offers a consistent return; so you can know what to expect. Of course, the risk for default is high compared to investment-grade bonds, but that does not imply that a high-yield bond will always default. As a matter of fact, a high-yield bond might bring home a more stable return over stocks.
Credit ratings increase bond prices
If the credit rating of a bond is not as good, then there is a greater opportunity for it to get better. It is not the same for AAA-rated bonds. So if the bond-issuing company gets a better rating from either of the agencies, then there is a good chance that the bond’s price will go up.
Great for portfolio diversification
If you are a serial investor, then you probably know that investing in a single class of assets is often a risky move. Thus, diversifying your portfolio is one of the safest things to do. Including a diverse group of high-yield bonds in your investments can help in portfolio diversification if your assets are in accordance with your investment goals.
Lowered sensitivity to interest rates
PIMCO, a leading bond investing firm, states that high-yield bonds are less prone to interest-rate changes, thanks to them being shorter-term. In most cases, junk bonds have a term of ten years or less. Hence, they are less susceptible to interest-rate sensitivity than bonds with longer maturity periods.