Behind the associated risks of high-yielding bonds

Because of their higher risk of default, they have to yield a higher return than investment-grade bonds. 

High-yield bonds typically carry a rating below “BBB” by S&P and below “Baa” by Moody’s. Bonds with ratings at or above these levels are considered investment grade. 

Credit ratings can be as low as “D”, or currently in default, and most bonds with a “C” rating or lower carry high risk of default. To compensate for such risk, yields will naturally be very high. 

However, the local investment outlook is highly volatile, especially in the stock market, which also sports a lower interest rate trend. High-yield bonds are an alternative for investors with a greater opportunity to earn higher yields.

High-yield bonds are also corporate bonds issued by medium-sized or small companies to raise funds for operations instead of bank loans. Most of the issuers are new companies without assets to guarantee bank loans, so their bonds are rated as non-investment grade. 

Some companies may issue unrated bonds in modest amounts because they are small companies and it is costly for them to hire a reputable rating agency to rate their bonds. However, high-yield bonds offer higher interest rates than investment-grade bonds in order to compensate for higher credit risks.

Now, investors interested in high-yield bonds can proceed through an accredited investor fund (AI Fund), a new feature of mutual funds for investment in unrated or non-investment-grade bonds freely on the invested proportion or even fully invested. It is an alternative to broaden investors’ chances of reaping higher returns. 

Because an AI fund bears higher risk than a general fixed-income fund, it is offered only to investors defined by the SEC as accredited investors and high-capital ones with higher risk-taking capability and requiring less protection than that offered to other retail investors. 

Investors can also invest in foreign high-yield bonds through mutual funds by investing in a feeder fund that goes into a master fund, designed to invest mainly in high-yield bonds.

However, since every investment comes with risk, investors should deliberate all risk aspects before spending their money, such as investment horizons and cashflow during investment periods. 

Also, they should be aware of the special features of each kind of fixed-income instrument, such as interest payments to investors and investors’ tax benefits, to maximise gains.

Investment encompasses risk. Please carefully study fund prospectuses before making your investment decisions.

 

_ Ladawan Charoen-Rajapark, is Managing Director, Asset Plus Fund Management