Why high-yield bonds continue to remain attractive for investors
What constitutes a high-yield bond?
In this section, we’ll be analyzing the deal flow and volumes in the primary and secondary markets for high-yield (JNK) bonds. High-yield bonds (HYG) are rated below investment-grade, i.e. BB+ and below, as per the Standard & Poor’s ratings system. Credit ratings are an assessment made by ratings agencies like Standard & Poor’s and Moody’s that provide an opinion on the borrower’s ability to adequately service the debt issued. In general, higher ratings imply lower credit or default risk, while lower ratings imply the opposite. Higher risk or lower rated bond offerings pay higher interest to investors, for assuming greater risk and vice-versa.
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Primary and secondary capital markets
The market for stock (VOO) and bond (BND) securities can be divided into the primary and secondary markets. Transactions made in the primary market for high-yield bonds, refer to the bond sales made directly by issuers. After the initial sale, securities may trade or change hands in the secondary market (for example—on the New York Stock Exchange). Retail investors may purchase bonds either directly in the primary market or on the secondary market, through brokerage accounts with brokers like Charles Schwab Corporation (SCHW) and E*Trade Financial Corporation.
Capital market conditions stimulate borrowers
Issuers in the high-yield market are taking advantage of historically low yields brought about by the Fed’s accommodative monetary policy, to fulfill their financing needs. Yields on high-yield debt (as represented by the Bank of America Merrill Lynch U.S. High-Yield Index) had fallen to 5.32% on June 6, 2014—their lowest level since May 10, 2013. The Option Adjusted Spread (or OAS) (as measured by the BofA Merrill Lynch U.S. High Yield Master II Option-Adjusted Spread), at 353 basis points, is the lowest since July, 2007.
In its April Federal Open Market Committee (or FOMC) statement the Fed reiterated that low yields would persist for some time even after the Fed’s twin goals of full employment and inflation target are met. As a result, high-yield bond yields continue their downward trend, and have fallen by 59 basis points since the start of 2014, due to the Fed’s dovish stance.
These factors were reflected in the high-yield issuance deals last week, with borrowers managing to price issues competitively and make the most of the prevailing low yields. Continue reading the next section in this series to learn about the major primary and secondary market trends in the high-yield market last week.