What Are High-Yield Bonds? Risk vs Return Explained for Indian Investors

High-yield bonds are fixed-income investments offering higher returns in exchange for greater risk. They’re issued by companies with lower credit ratings and are ideal for investors with a high-risk appetite. Think of a bond like giving a loan to a company or the government. In return, they promise to pay you interest regularly and give your money back after a certain period. It’s like how a business might give credit to a trusted supplier and expect steady payments. But not all bonds are the same. Some offer higher returns because they carry more risk. These are called high-yield bonds. They are usually offered by companies with lower credit ratings but the potential to grow fast—and that’s what makes them both exciting and a bit risky.

Understanding High-Yield Bonds

What Are High-Yield Bonds? – Feature Snippet friendly Box content to be added
High-yield bonds are fixed-income securities that offer higher interest rates than traditional bonds. Issued by lower-rated companies (below BBB), they carry greater risk but also offer potential for higher returns and capital appreciation.

High-yield bonds are a type of debt securities from issuers typically rated below BBB. They offer higher interest rates due to their higher risk of default. When a company with a greater risk of default issues debt securities, it provides higher interest rates to entice investors. Therefore, they are most suitable for investors seeking high returns and are ready to take greater risks.

Although they have the potential for price appreciation when the economy improves, or the issuing company performs well, the prices may decline if conditions worsen. Highly leveraged companies or those facing financial difficulties often issue these securities. Emerging or smaller companies also issue them to offset their inconsistent operating histories and risky financial plans.

Features of High-Yield Bonds

Let’s look at the features of high-yield bonds to understand them better:

  • Bigger Returns: The bond issuers offer higher interest rates on these securities or potentially trade them at lower prices. As a result, the yields earned are higher than other investment-grade and higher-rated options.
  • Issuers: Common issuers of these instruments are start-ups and small businesses. These companies have no or poor credit rating due to no or less borrowing history. Their credit ratings are usually below BBB, meaning they are risky avenues with bigger returns.
  • Shorter Maturity Dates: Typically, these investment instruments have shorter maturity dates compared to other debt securities.

Benefits of Investing in High-Yield Bonds

High-yield bonds offer various benefits but with specific risks. Investors can manage them by diversifying their portfolios across regions, industries, and issuers. Below are some key benefits of investing in these debt securities:

  • Portfolio Diversification: Their low co-relation to the fixed income market enhances portfolio diversification by adding high-yield instruments. Diversification decreases the overall portfolio risk and improves yield consistency.
  • Equity-Like Return Potential: High-yield bonds respond to the market environment similar to equities. However, the returns are less volatile due to larger income components in debt securities. Over the long term, these instruments offer equity-like returns.
  • Capital Appreciation: If the economy improves or the issuing company performs well, it can significantly impact the price of high-yield debt securities. Events that may boost the bond’s price include management changes, mergers and acquisitions, improved ratings, upgrades in earnings reports, market-related events, product developments, etc. Platforms like Bondbazaar provide investors with transparent access to a wide range of such high-yield bonds, enabling them to explore opportunities and trade bonds with real-time pricing and zero brokerage, making it easier to capitalise on market movements
  • Additional Income: High-yield securities offer higher interest rates to entice investors. However, they may vary based on the economic environment. The default risk increases during downturns and diminishes during improvement phases.

Risks of Investing in High-Yield Bonds

Investors with investors with aggressive risk profiles often find high-yield bonds appealing. However, it is important to consider the risks involved. Let’s look at the bond risk types involved with these instruments:

  • Default Risk: Default risk, or credit risk, refers to the risk that the company may not make interest payments or repay the principal if it defaults. A default usually occurs when the issuing company fails to meet its debt agreement terms. Since these securities often come from high-risk issuing companies, bondholders’ risk is even higher.
  • Interest Rate Risk: The prevailing interest rates in the market largely impact bond investments. A bond’s price is inversely related to the market interest rate. In addition, securities with longer maturities have more time for rate changes. Therefore, choosing a high-risk bond with a shorter maturity is better.
  • Economic Risk: Investors try to sell their securities if the economy weakens. Under such circumstances, investors replace their riskier investments with safer ones. However, if the number of sellers increases significantly, the supply exceeds demand, and bond prices fall. Moreover, if the issuing company fails to tolerate the economic circumstances, the default risk increases significantly.
  • Liquidity Risk: Liquidity is the ability to sell the asset when the investor wants. Bonds with frequent trading have higher liquidity than those with less frequent transactions. Liquidity risk refers to the risk that an investor may not receive the bond’s true value when they sell.

Points to Check Before Investing

Be sure to check these points before investing in high-yield bonds:

  • Covenant Protection: Covenants protect bondholders by restricting a company’s actions that negatively affect its repayment capacity. They also protect the bondholders’ right of priority over stockholders.
  • Payment Terms: Some bonds allow issuers to skip interest payments under specific conditions or pay interest in the form of more bonds instead of cash. Investors must understand the payment terms before investing.
  • Call Provision: The provision allows the issuer to call the debt and repay it in full before maturity. One must understand the call terms that might result in early payment, after which they may need to reinvest the money at a lower interest rate.

Like any investment instrument, high-yield bonds also have rewards and risks to consider.Iinvestors with aggressive risk profiles may use these bonds to achieve their financial goals. However, they are unsuitable for conservative investors seeking safe investment avenues to park their money. Open an account on reliable platforms to find a range of options suitable for your goals and risk tolerance. Choose the instruments according to your income, investment goals, risk appetite, net worth, and investment horizon.