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Should You Go Active With High-Yield Bonds?

Indexing may not be the best route when it comes to risky credit.

In mid-February, the Financial Times reported that the latest round of junk-bond deals carried the largest slug of debt rated CCC or lower since 2007. The article (subscription required) covered only the first six weeks of the year and a limited dataset, so it may be a little premature to call that a trend. If it becomes one, that will be something of a reversal given that issuance in the high-yield market has been migrating to its higher rungs in recent years, as the investment-grade market has become more concentrated in its lower tiers. In fact, that investment-grade trend triggered plenty of anxiety as valuations became increasingly tight in 2018 and 2019, leaving less room for error in BBB debt pricing. Therefore, it wasn't surprising when the early-2020 coronavirus-driven sell-off pummeled BBB bonds nearly twice as hard as it did AAA rated corporates.

The entire universe of junk bonds is orders of magnitude smaller than the pool of BBB rated corporate debt alone, so borrowing trends in leveraged businesses can sometimes trigger fundamental shifts in the market's makeup, particularly at the sector level. That happened after passage of the Telecommunications Act of 1996 led to a proliferation of smaller carriers looking to compete with large incumbent phone companies that still dominated telephony. Those startups found plenty of hospitality on Wall Street as bankers found it easy to sell debt while falling yields were driving investor dollars into a high-yield market enjoying double-digit growth.

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