High Yield Bonds are Becoming JunkSubmitted by Castlebar Asset Management on December 31st, 2012
Investors seeking yield are looking high and low for better yielding assets than corporate and government bonds. Dividend paying stocks received plenty of attention this year from both investors and the media. High yield bonds have been another beneficiary in this quest for yield. High yield bond funds have seen nearly $70 billion of inflows in 2012. This is double the inflows from its best year of 2009.
It is easy to see why investors seeking more yield in their portfolio would prefer the 5.8% yield in the HYG (iShares High Yield Bond ETF) to the 1.8% offered by the CIU (iShares investment grade corporate bond ETF). Credit spreads between high yield and investment grade have reached a point where investors may not be compensated enough for the risk they are actually taking.
Howard Marks of Oaktree Capital Management is quoted:
“This paradox exists because most investors think quality, as opposed to price, is the determinant of whether something’s risky. But high quality assets can be risky, and low quality assets can be safe. It’s just a matter of the price paid for them.”
There is a time to own high yield and a time to sell this asset class. High yield bonds may continue to move higher in 2013 but there is more risk associated with them for lower returns at current prices. Companies continue to flood the market with new bond issuance and some are forgoing paying interest by using payment in kind. This is done when a business usually does not produce enough cash flow to cover their interest expense so they pay their interest in buy issuing more debt. These have been historic signs that market is getting frothy.
After all there is a reason why they call these junk bonds.
Disclosure: Castlebar does not have a position for our clients in either ETF.