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High-Yield Bonds Offer More Income With Greater Risk
High-yield bonds are loans to companies that may have more difficulty repaying money.
They pay more interest to persuade investors to accept that extra risk.
If the company becomes weaker, its bond rating may fall and the bond’s price may drop.
It may also become harder to sell the bond quickly.
Investors could lose money if the company defaults.
Some bonds have collateral, but collateral does not remove all risk.
These investments are generally not meant for conservative investors.
Experts say they should usually be a smaller part of a portfolio, not its main source of fixed-income savings.
High-yield bonds pay more interest because issuers face greater repayment risk.
Risks include default, rating downgrades, illiquidity, interest-rate changes and concentration.
A downgrade can lower a bond’s market price even when interest payments continue.
These bonds may suit informed investors who can tolerate risk and hold until maturity.
Experts recommend keeping high-yield exposure smaller than core fixed-income holdings.
- Who
- Investors and bond issuers, with guidance from Souvik Biswas of Bajaj Capital and Rhishabh Garg of FundsIndia Digital.
- What
- The article explains the income potential, risks, suitability and allocation considerations for high-yield bonds.
- Where
- The discussion focuses on India while also describing global high-yield classifications.
- When
- The risks are especially relevant when investors sell before maturity or when an issuer’s financial position deteriorates.
- Why
- High-yield bonds offer greater interest income as compensation for higher credit and repayment risk.
Higher-Yield Opportunity
Higher-Risk Caution
Role in a portfolio
Higher-Yield Opportunity
High-yield bonds can provide potentially higher regular income and may suit investors who have already built a stable core fixed-income allocation.
Higher-Risk Caution
They should not replace core high-quality fixed income, and a default or major loss in one investment should not materially damage the portfolio.
Credit segments
Higher-Yield Opportunity
Investors may consider relatively higher-yielding AA to A+ bonds as part of a researched fixed-income portfolio, depending on their objectives and risk profile.
Higher-Risk Caution
Bonds rated BBB and below require considerably greater caution because of higher credit risk and possible capital loss after default.
Holding versus selling
Higher-Yield Opportunity
Investors able to hold a bond through maturity may continue receiving its contractual coupon and principal if the issuer meets its obligations.
Higher-Risk Caution
Selling before maturity can produce a loss because downgrades may reduce the market price and thin trading can make the bond difficult to exit.
Key facts
- Global classification
- Bonds rated below BBB are generally considered high-yield bonds globally.
- Indian classification
- Rhishabh Garg said bonds rated BBB and above are investment grade in India, while BB and below are high-yield.
- Potential alternatives
- Souvik Biswas said investors in India may find relatively higher-yielding opportunities in the AA and A+ segments without taking on the same risk as bonds below BBB.
- Main risks
- Default, credit-rating downgrades, liquidity risk, interest-rate risk and concentration risk.
- Maturity example
- A bond with 12–18 months remaining may provide a shorter period of exposure to changes in the issuer’s credit profile, though credit and liquidity risks remain.
- Suggested allocation
- High-yield exposure should generally be a smaller, satellite allocation within an overall debt portfolio.
Quotes
Souvik Biswas
Head of research at Bajaj Capital
“Since there is a higher perceived risk of repayment, investors are generally compensated through a higher yield compared with bonds that have stronger credit ratings.”
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Sources
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