Markets Explained

What Are the Benefits?

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What Are the Benefits?

Today’s bond market offers you a variety of choices, including U.S. government obligations, asset-backed securities and high-grade corporate, municipal and high-yield bonds. Investors are attracted to high-yield bonds because:

High yields can enhance your current income This yield premium is particularly attractive during periods of declining interest rates. Investors focus on the difference between yields on high-yield bonds and the yields on U.S. Treasuries or other issues of comparable high credit quality. During much of the ’80s and ’90s, this difference—called a “yield spread”—has typically been about 300 to 400 basis points (3% to 4%) for securities of comparable maturities. You should be prepared to accept the trade-off of higher yields for increased risk for at least a portion of your assets.

Capital appreciation potential Positive events in the economy, industry or issuing company can reward you with increases in your high-yield bond’s price, otherwise known as capital appreciation. These events include ratings upgrades, improved earnings reports, mergers or acquisitions, positive product developments or market-related events.

Security If a company is liquidated, bondholders usually have priority over stockholders in a company’s capital structure and are more likely to receive payment. The percentage of this payment compared with the original investment is called the “recovery rate.” As the table below shows, the holders of “secured debt” and “unsecured senior debt” have the highest claim on corporate assets in a bankruptcy distribution. Even the holder of a low-rated bond is entitled to a share of a failing company’s assets ahead of preferred or common stockholders.

Portfolio risk diversification High-yield bonds are often considered a separate asset class, involving different characteristics from those of other securities. High-yield bonds can help you spread assets across different segments of the financial market, reducing your risk concentration in any one asset class in your overall portfolio.

Less interest rate volatility risk than long-term U.S. Treasury bonds Prices of all market-traded fixed-rate bonds are affected by interest rates. If rates move up, bond prices move down (and vice versa). In general, the longer a bond’s maturity, the more vulnerable its price is to interest rate fluctuations. High-yield bonds are typically issued with maturities of 10 years or less, and are callable after four to five years.

Total return performance The “total return” performance of high-yield bonds includes price changes and reinvested interest income. In general, high-yield bonds tend to produce attractive total returns when the economy is growing and interest rates are stable or declining.

Priority of Claims

Secured Debt Holders
Unsecured Senior Debt Holders
Other Unsecured Subordinated Debt Holders
Preferred Stockholders
Common Stockholders

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