By Aviva Investors
Bonds are used by companies to raise money, borrowing from investors. Global High Yield bond funds are unconstrained by geography and differ from government bond (gilts) and investment grade bonds, which are typically more secure but offer lower returns. As a result, Global High Yield bond funds tend to offer a higher level of income than their government and investment grade counterparts. Yet there are still some risks to be aware of.
Remember: investments can go down as well as up and you could get back less than you initially invested.
What to expect from Global High Yield Bond funds
The reason high yield bonds can pay higher levels of interest rates than the likes of government bonds and investment grade bonds is because they’re higher risk. There’s a greater chance that the lender of capital may default on the payments to investors. As a result, these bonds are given lower credit ratings and pay a higher yield to compensate investors.
As well as the potentially higher level of income, positive events in the economy, industry or issuing company can potentially reward investors with increases in the prices of the high yield bonds. This is otherwise known as capital appreciation. Events such as ratings upgrades, improved earnings reports, positive product developments, or market-related events can lead to this. Of course, the reverse of this can work against the price of the bonds as well.
You’ll often find that start-ups and capital-intensive companies issue high yield debt. They want to raise money for growth, working capital, or cashflow purposes. Some may even want to refinance existing loans or debt.
How has the GHY sector performed?
In positively performing markets, high yield bonds can offer a relatively smooth return profile as companies go about their normal business and pay their debts, and so can deliver an income to investors. This is mainly driven by the fact that companies issuing bonds are obliged by the terms of the bond, set out in legal documentation, to pay interest and ultimately fully repay bondholders.
However, downturns in the business cycle, often caused by adverse economic conditions, can be negative for high yield bonds. Companies may find their credit ratings downgraded, impacting their ability to borrow. They may be unable to meet the interest payments on their debt as conditions become tougher and revenues decline. Widespread selling of riskier assets in times of market stress can also cause negative price effects for the asset class.
These factors were certainly observed in the COVID-19 crisis, where riskier assets such as high yield bonds sold-off particularly badly. But they do tend to recover quickly as investors look to “buy the dip” – much like with equities. Buy the dip refers to buying a stock when the price is low with the hope that it will rise again later, and you can make more on your investments. Government stimulus packages and central bank measures were another aid for the recovery of the asset class in 2020.
Investors willing to take a long-term view when investing in the Global High Yield sector, and look past short-term fluctuations, can be duly rewarded.
Should you consider Global High Yield Bond funds?
For investors looking for alternative sources of income, or those who are dissatisfied with the income they are receiving on other asset classes, the Global High Yield Bond funds could provide some of the answers. Investors should be cautious given the risks, but there could be potential for higher levels of income.
High yield bonds can also help you spread assets across different segments of the financial market. This could potentially reduce your portfolio’s concentration in any one asset class, which can help achieve portfolio diversification.
In addition to this, bondholders usually have priority over stockholders (equity holders) in a company’s capital structure. Consequently, they are more likely to receive payment in the event the company goes bankrupt. Even the holders of a low-rated (high yield) bond are entitled to a share of a failing company’s assets before preferred or common stockholders.
How could you use a Global High Yield Bond fund?
It’s important for Global High Yield Bond funds to be used alongside other asset classes to achieve diversification – whether that be in terms of geographical exposure or income sources. Using it together with other fixed-income products, such as government and investment grade bonds, could potentially create a useful blend of higher yield and downside protecting investments.
In choosing a Global High Yield Bond fund, it may be useful to find a manager who considers Environmental, Social and Governance (ESG) factors in their investment process. It’s an asset class where a lot of resource-intensive companies source their capital from, so it’s down to the fund managers to determine whether that’s done sustainably and if the bonds are suitable to be included in the portfolio.