Navigating High-Yield Bonds: Opportunities, Risks and Fallen Angels

This strong performance can be attributed to several key factors, including healthy investor demand, limited net new supply, robust corporate issuer fundamentals and historically low default rates.

Additionally, despite broader macroeconomic uncertainties, high-yield returns and credit spreads (the excess yield offered over Treasuries) have shown remarkable resilience and relatively low volatility.

We Remain Constructive on Higher-Quality High-Yield Credit

While the spreads on high-yield bonds have now compressed to relatively low levels, we maintain a constructive outlook on the higher-quality segment of the high-yield market. Here’s why:

By focusing on higher-quality issuers, investors can benefit from the attractive risk-adjusted returns and income offered in high yield, while also mitigating some of the risks associated with lower-rated debt.

Not All “High-Quality” Strategies Are Created Equal

One popular way for investors to access the higher-quality portion of the high-yield universe is through “fallen angel” strategies. These strategies target bonds that were previously rated investment grade but have since been downgraded to high yield.

However, after a period of limited issuer migration, the risk of fallen angels has surged this quarter, particularly due to Boeing’s $57 billion in outstanding bonds, which are under review for possible downgrade by Moody’s.

While fallen angels may offer enticing yields, the prospects of a Boeing downgrade could dramatically increase the issuer concentration risk in these strategies, some of which have issuer caps as high as 10%!

Given the risks associated with issuer concentration in fallen angel strategies, we suggest that investors consider a broader approach to the high-yield market. Rather than relying solely on credit rating history, we believe it’s prudent to use strategies that systematically identify fundamentally strong issuers across the market.

In summary, the high-yield bond market continues to present a compelling investment opportunity for those seeking strong returns with lower volatility than equities. With careful issuer selection and a focus on quality, investors can still find attractive opportunities in today’s market environment.

This article originally appeared on WisdomTree's website and is reprinted on VettaFi | Advisor Perspectives with permission from the author. For more information, please visit WisdomTree.com.

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