Given that interest rates are likely to rise further, and that junk bond valuations have declined over the last year and a half, investors may want to shop for a little junk to add to their portfolios.
The last few weeks have seen the high-yield bond market in the news for all of the wrong reasons. Third Avenue Focused Credit Fund -- a mutual fund that specialized in investing in high-yielding loans and securities issued by struggling companies -- halted redemptions. On the heels of this news, several junk bond hedge funds announced they were closing their doors. This sent shocks waves through the credit markets and prices of junk bonds plunged, leaving many pundits suggesting that this event signaled the beginning of the next financial crisis. While it doesn't appear that these events are indicative of systemic problems in the credit markets, the events serve as a not so gentle reminder that high-yield bonds are also known as "junk bonds" for a reason.
High yield bonds become very attractive to many investors when yields in the bond market are low. If an investor has a specific yield target in mind, he needs to buy lower and lower rated bonds to earn that yield when market interest rates are particularly low. Junk bonds also become attractive when investors' aversion to risk decreases. We recently experienced the perfect storm in that investors were more and more willing to accept credit risk in a historically low interest rate environment. And, it seems, the memory of the financial crisis has faded all too quickly for many market participants.