Junk Bonds are now yielding less than 4%, a record level. What does this mean for investors.
The yield of the junk-bond market fell below 4% for the very first time.
The average yield on junk bonds tracked by the Bloomberg Barclays US Corporate High Yield Index fell to 3.96% on Monday, the lowest yield on record. Another index that tracks the market, the ICE BofA US High Yield Index, returns 4.01%, also the lowest on record.
High yield borrowers have benefited from the rally in risky markets that sent the S&P 500 to record highs. As vaccines are distributed and economic growth improves, investors are more optimistic about lower-rated companies, which tend to be sensitive to economic growth. The
(HYG) and the
(JNK) are each up almost 0.6% so far this year.
Junk Bonds now yield on average 3.3 percentage points more than Treasuries with comparable maturities; although this is not the lowest spread on record, it is the lowest since the start of 2020, before Covid-19 hit.
This is an unusually narrow gap at a time when the economy is emerging from a recession, Morgan Stanley Wealth Management noted in a recent memo.
“The Federal Reserve’s aggressive accommodation crushed spreads, making them tighter than they usually have been at this point in the recession,” wrote Lisa Shalett, chief investment officer. “Building fixed income portfolios from here depends on creativity and using more non-traditional investments. ”
Although it did not specify specific types, investors can achieve higher returns by investing in loan fund and more complex vehicles such as mortgage real estate investment trusts, business development companies, and secured loan obligations.
Low yields on risky bonds highlight a lingering challenge for investors: As growth expectations improve, they must move into riskier or more complex parts of the markets to earn income and returns.
Granted, this is part of the Federal Reserve’s efforts to spur economic recovery, as low interest rates make it easier for lower-rated companies to access credit. And the effort seems to have paid off: companies rated CCC +, CCC and CCC-, the three lowest levels before default (or near-default), have set weekly borrowing records twice this year, according to a report. recent note from Bank of America. .
The “valves of the CCC [are] wide open, ”wrote the bank’s strategists on February 5. “Credit conditions [have] has continued to improve remarkably in recent weeks.
Lower-rated bonds have also posted the best returns so far this year, despite the increase in supply. The ICE BofA CCC & Lower US High Yield Index posted a return of 2.4% in 2021. And for this segment of the market, bond yield spreads over T-bills are close to the narrowest on record, according to Bloomberg data.
The broader junk market returned around 0.4%, which may seem meager compared to the S&P 500’s 4.1% price gain this year. But junk bonds have consistently outperformed higher-rated bonds: the investment-grade bond market has lost 1.2% so far this year, according to ICE.
Junk bonds have found some support due to a few characteristics: low maturities and high coupons. To compensate investors for their higher risk of default, lower-rated companies typically need to issue bonds with shorter maturities and higher coupons than higher-rated debt.
In other words, the duration of the market, its sensitivity to interest rates and Treasury yields, is lower than that of higher rated debt. This will likely help this market outperform investment grade corporate bonds.
“Investors who believe that the damage to fixed income instrument prices caused by rising interest rates can, as is often the case, be offset by tightening credit spreads may be disappointed,” wrote Shalett of Morgan Stanley.
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