High Yield Bond Funds

Reviewed: July 16, 2014
By FinanceWeb

After good performance in the first half of 2014, some analysts express concern that the bond market may fade. However, in large numbers, investors still look to high yield bonds as a means to improve overall return on investment. Investors know these bonds offer higher yields than more highly rated bonds, because they are vulnerable to economic conditions. Backed by unrated or low rated assets, these bonds have credit and investment risks. In a typical situation, agencies have either not rated the assets, or rated more than two thirds at BB or lower. However, in a period when interest rates have been low and steady, mutual funds focused on high yield bonds offer some advantages.

Source Of Diversity

High yield bonds are an important means of diversifying a fixed income portfolio or a mutual fund portfolio. It is an excellent method for reaching into sectors that show short-term promise. Skillful mutual fund managers can pick winners from volatile sectors like older issues of commercial mortgage-backed securities. Among the sectors favored by managers at top rated funds are energy, cable entertainment, and telecommunications. Managers favor these sectors because issuers have assets to cover short-term investment cycles.

Information Is Key

When selecting high yield investments, fund managers contend with the difficulty of getting good information about issuers. Unlike many large corporations, governments, and municipal issuers, information is not easily available on small or less well-known companies. Many fund managers take advantage of institutional assets, such as extensive credit research, to identify strong candidates. Others use techniques to identify prospects. For example, some note companies in which insiders have purchased large amounts of stocks.

News And Events

World and national news and events can affect bond markets, and investors must pay attention to these factors. In Eastern Europe, the situation between Russia, Ukraine and Central Europe has had some deep impacts on financial markets. There are promises of growth in the recent EU trade agreements with Ukraine, Moldova, and Georgia. There are signs of difficulty in the Russian economy. For example, the IMF has issued statements reflecting concerns with sharp contractions in the Russian economic growth because of international sanctions. In the Middle East, the situation in Iraq has affected global oil prices. The energy sector is a significant source of high yield bonds.

Noteworthy Trends

Analysts and institutions have cited a potential market difficulty from the volume of issued high yield bonds. Sharp increases in bond volumes on the market affect prices and yields. However, analysis suggests that this is more of an appearance than a fact. Upon detailed reviews of recent bond issuance, analysts have determined that a significant amount of new issues represent older debt. This has reduced the level of concern. Among other noteworthy trends are the role of the Federal Reserve in the mortgage-backed sector, and the trend line on interest rates. Many analysts predict that as Federal Reserve bond buying programs taper-off in the second half of 2014, markets will emerge for mutual funds in mortgage backed securities. Investors watch for changes in the interest rates as signs of change in federal monetary policies