Fixed Income  

Shaken, not stirred

Despite the risk for some investors, junk bonds undoubtedly have their place. They enable diversification and offer access to higher returns. But given their nature and the warning signs, investors should be wary. People need to realise that there is a real chance they will suffer losses in the market over the short to medium term.

Investing in junk bonds also requires specialist knowledge of the debt and credit markets and quite often a high degree of analytical skill. Investing in an active fund enables the utilisation of professionals, albeit for lower returns from the sector - Axa’s Global High Income Fund having returned 1.25 per cent over the last year. Investors using tracker funds in the sector should certainly exercise caution however, as they expose themselves to the total risk of the market.

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Junk bonds are also sensitive to overall economic performance and the individual issuer. They are more volatile than investment-grade bonds and in many ways behave more like equities when it comes to trading.

At a time when investors are piling into higher risk sectors and depressing yields, there becomes a point when, particularly in absolute terms, the returns simply do not justify the risks.

In this environment where should sophisticated and high-net worth investors look for yield? One answer might be SME bonds. Medium-sized private non-financial corporations is now the segment most starved of access to credit across all UK business, according to the recent Bank of England Trends in Lending report. By participating in this underserved segment, investors are able to access attractive yields investing in what are arguably relatively creditworthy companies. Importantly, investors can also benefit from security – as long as they choose the right platform or fund.

Before investing, people should check the company in which they are investing has a demonstrable track record in its sector. They should also see if the company has undergone human credit assessment, extensive professional due diligence, as well as legal verification.

While investing in large corporates through junk bonds has its place for informed investors, the potential for high returns may be coming at too high a price. Given this environment, it is unsurprising that we are seeing more and more advisers introduce their clients to SME bonds when looking for high yields, but with more palatable risks.