In the current investment market situation high yield bonds have become one of the major investment instruments. However, committing to something without knowing the entire picture might not be the right approach.
So in this article, the advantages and disadvantages of the high yield bonds will be discussed.
Advantages of High-Yield Bonds
Below the main reasons for investors opting for high-yield bonds are shared:
High Yield Bonds Lower Defaults
The risk and reward situation of the high yield bonds is very similar to any equity investor scenario. Higher the risk better the return on the investments made.
But an added benefit to this scheme is that bonds usually have the priority claim over the company’s assets compared to other equity shareholders.
Thus, in case the company defaults, the investors of high-yield bonds will get the value of their investments first.
Thus, if you have come across the news that these bonds are prone to default, it might be true, however, the risk of incurring losses is lower than equity investment.
Significant Appreciation
When it comes to the value appreciation of high-yield bonds, the basic concept remains equity investment. As the risk profile of the underlying company improves, the return on the such bond will also go up.
One of the main reason for this is because the high yield bonds are not significantly impacted by external interest rates but depend highly on the financial performance of the underlying company, when its financial position and credit rating improves so does the quality of the debt fund.
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High Yield Bonds Diversification
Diversification remains one of the most needed elements in a portfolio to date and these bonds are just the best investment asset class to bring that to the table.
This is because in most cases the high-yield bonds tend to move in the opposite direction of any government-issued fixed-income securities or debt instruments of any corporation.
Hence, if your portfolio has more weightage in fixed-income securities, adding high-yield bonds to the mix will stabilize the risk and return factors of the portfolio.
High Yield Bonds – Better Coupon Rates
Another best part about these bonds is that the return provided on them is quite lucrative and tends to be approximately 2-3% higher than that of the other fixed-yield investment options.
Thus, when the money remains invested in these securities for a long time, the yield on them becomes significantly higher than any regular bond.
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Disadvantages of High Yield Bonds
Many times the disadvantageous past of the similar bonds gets shadowed by the high profits it generates. However, you must know the complete details about the security before committing to it. The disadvantages are mentioned below:
Low Liquidity
High-yield bonds, in general, are not considered to be of investment grade.
Thus, not many institutional investors easily trade in this investment security and since the major segment of the financial market is ruled by institutional investors, they are not actively traded.
And low-selling opportunities bring less flexibility to the asset class. And low liquidity equals inconvenience on the part of the investors.
High Volatility
When it comes to volatility, just like high-yield bonds provide high returns they also are highly volatile.
Security tends to increase at a very high rate however as soon as the market starts to go down, it start to take a turn toward the worst possible direction. During a recession, multiple of these bonds start to default.
Callable
One of the biggest issues with these high-yield bonds is that they are prone to be called even before you, as an investor, can reap all the benefits of taking the risks.
Now say, for example, a company may not be in a good position financially but can increase its credit rating over time.
However, to avoid paying for higher returns, they might call the bond, devoiding you of earning higher returns. And the thing with these bonds is that organizations do tend to call them quite frequently.
Shorter Maturity
Another disadvantage with these bonds is that they have a shorter maturity, meaning that you will not be able to benefit from the high yields for a long time.
Moreover, as previously discussed, since they are callable, this adds to the whole short maturity situation.
Conclusion
Thus, the deduction that can be made from the above information is that high-yield bonds are best suitable for investors who are open to taking high risks.
If you are looking for more stable and long-term investment options, you might want to explore a few more investment instruments before choosing one.
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