The risks with high yield bonds funds in 2020

By: Robert Bell
Robert Bell
Having worked for years in the UK banking industry, I began writing and reporting financial markets after migrating abroad… read more.
on Mar 27, 2020
Updated: Apr 3, 2020
  • They bonds offer bigger returns but more risks
  • High yield bonds have lost a lot of value in 2020
  • Poor credit ratings make them deafult risks

High yield bonds provide a better return than most other bonds in over the long term. They offer a way of diversifying an investment portfolio but you need to know which ones are best right now.

To start with, we need to understand that high yield bonds cover borrowing from companies with poor credit grades, such as start-ups. Let’s see what this means in the current economic climate and looking to the future.

The coronavirus situation

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At this time, it is impossible to talk about investing in bonds or anything else without mentioning the coronavirus outbreak. People tend to think of bonds as safe havens when the stock market goes through a turbulent period like it has done lately.

However, not all bonds are the same. While the likes of treasury bonds are safe and steady, not all of them are like this. High yield bonds are among the riskiest.

There were hopes that the Federal Reserve bailout package would help this sector of the investment world too. The fact that it did to a degree has caused these bonds – also known as junk bonds – to steady somewhat.

The risk of default is the biggest fear. This is why many investors have decided to move out of them into something safer. The prices have fallen as more people sell up. A record £30.5 billion moved out of American bonds of this type in the last week, after £29.4 billion was moved the week before.

This has caused some of the bonds to lose over 20% in value this year to date. It looks like the situation might get even worse, as a global recession appears to be on the cards.

There was a rally towards the end of this week, as US high yield bond funds gave their best single-day performance since 2009. Among the best performances were a 3.7% increase on The iShares iBoxx High Yield Corporate Bond Fund and a 3.5% uplift in the SPDR Bloomberg Barclays High Yield Bond ETF.

Which high yield bonds are best avoided?

There are plenty of risks to look out for here. For instance, the energy industry makes up a fairly large percentage of some high yield bonds. The crash in oil and gas prices will have a huge effect and will almost certainly cause a high level of defaults.   

Another sector at risk is the consumer industry. With retail sales plummeting, this is another area where normal business has been disrupted and defaults are to be expected.

Summary

Don’t be fooled into thinking that bonds are automatically the best choice for making a safe investment in these difficult times.

High yield bonds have been extremely volatile in recent weeks and could carry on losing value for the time being. They offer higher possible returns because they are based on companies with lower credit ratings. Now is a risky time to invest in bonds of this type.  

However, they will continue to attract investors who are happy to take a chance in return for the prospect of a better than average profit.

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