Safety-seeking investors are taking on more risk these days, but they’re not buying stocks.
Today’s conservative investors hate stocks. What they love are bonds, although no one’s happy with those atrociously low bond yields.
And so, high-yield bond funds have become the new big thing in bond investing. A simple description for the uninitiated: much higher returns, much higher risk. Hey, isn’t that what the stock market’s all about?
High-yield bonds are issued by companies that are weak financially and present a higher risk of default than blue-chip companies or governments. Added judiciously to the holdings of an investor who understands the risks, high-yield bond funds are a totally valid and effective tool for generating returns that right now can run to 6 or 7 per cent.
But you have to wonder whether the dark side of high yield is being overlooked at a time when investors are fixating on income-paying investments of all types.
“Everyone’s asking about income,” Oliver McMahon, director of product management for iShares ETFs at BlackRock Canada, said this week as his firm launched a new exchange-traded fund containing high-yield bonds.
RBC Asset Management announced the upcoming launch of a high-yield mutual fund this week at the same time as it announced its Phillips, Hager & North High Yield Bond Fund would close to new money on Nov. 26. The PH&N fund is basically too popular – sterling results are drawing in more money than the managers can comfortably handle.
“Rather than buying traditional bond funds, people are increasingly looking at higher-yielding bond products as a way to diversify their fixed-income holdings,” said Jonathan Hartman, vice-president of investment products at RBC Global Asset Management.
High-yield bonds, sometimes known as junk bonds, have been around for decades but never achieved fad status. That may be happening today as yield-hungry investors have prompted record bond issuance by companies with lower-tier credit ratings. Data from CIBC World Markets show that $2.5-billion in high-yield bonds has been sold this year, compared with $1.2-billion last year, virtually zero in 2008 and $425-million in 2007.
More bonds have meant more high-yield mutual funds and exchange-traded funds for investors. The number of high-yield mutual fund choices has increased by 32 per cent in the past 12 months – to 143 from 108. In the ETF world, the BMO, Claymore and iShares families have each launched at least one product devoted to high-yield bonds in the past year or so, and there are also hybrid products like the iShares DEX HYBrid Bond Index Fund (XHB) unveiled this week.
This fund tracks an index of Canadian bonds that is 82-per-cent weighted to investment-grade corporates with a triple-B rating and 18-per-cent weighted to high yield. Most high yield funds rely mainly on the U.S. market because it’s much bigger and thus easy to trade in and out of bonds at competitive prices. A move into Canadian high yield raises the question of whether our comparatively tiny, illiquid market will exact a performance penalty on XHB.
“We have no concerns whatsoever about this,” said BlackRock’s Mr. McMahon. “The high-yield market in Canada is relatively small, but it’s growing very quickly.”
The bond fund managers at Canso Investment Counsel have taken a look at the new high-yield bonds coming to market and they’re not much impressed. One complaint is how low bondholders rank among creditors in case of a bankruptcy.
“There’s a lot of high yield lately that is very risky, very badly structured,” said Heather Mason-Wood, a Canso vice-president.
Her colleague, Richard Usher-Jones, came up with this vivid characterization of high yield as a market niche where demand from investors has resulted in lower-quality securities: “High yield is the new income trust market.”
