Why High-Yield Rally Is Too Risky for Some Investors
High-yield debt markets have soared 19 percent over the past year while global Treasuries lost 1.2 percent through the open of this week’s trading – a gap that’s prompting some investors to say that junk bonds have gotten too risky. According to Bloomberg, Canadian investment firm RBC Global Asset Management has decided to cut the junk allocation in its $38 billion worth of global fixed-income portfolios in half, to 3% from 6%. Instead RBC is buying high quality global government debt. While some investors are still chasing yield, RBC and others are beginning to claim that the added risk is not worthwhile under current conditions. (For more, see: Junk Bonds- Everything you Need to Know.)
Junk Bond Rally and Caution from RBC
Junk bonds, which have lower than average credit ratings, have soared as global bond markets have lost ground on inflation fears and expectations that President Donald J. Trump’s pro-growth economic plans will boost both interest rates and the U.S. dollar. The Bloomberg Barclays Global High Yield Index (BHYC) returned 19 percent over the 12 months as of Monday while safer bonds lost ground. The iShares iBoxx High Yield Corporate Bond ETF (HYG) is similarly up 11.5% over the past year through Tuesday. Junk bonds have been given a boost as a compression in spreads for these bonds versus Treasuries occurs. An optimistic outlook for the economy may send interest rates higher, lowering the prices of many bonds. But at the same time, a growing economy increases the likelihood that the companies issuing this risky debt will be able to pay it off without defaulting, which in turn lowers their yields and increases their prices. (See also: Are Junk Bonds the New Equities?)
RBC’s fixed-income asset management team is finding this disparity overly risky. Dagmara Fijalkowski, who runs the company’s global fixed-income billion portfolio, told Bloomberg, “The probability of especially risky credit outperforming government is not attractive, I’d rather stick with my government bonds.”
Over the next six months, RBC forecasts that the U.S. 10-year Treasury yield will rise 30 to 40 basis points to around 2.75 percent, with Canadian rates rising less so, according to Bloomberg. Fijalkowski says there will be a small narrowing of credit spreads but not a big benefit in holding U.S. dollars, unless it’s a hedge against high-yield risk.