Investors are Gorging on Junk Bonds


Prices of “junk” bonds keep rising as investors continue to buy the riskier debt.  Yields on junk bonds, which move inversely to bond prices, settled at a record low of 5.56% recently.  Demand for junk bonds is part of the yield-seeking behavior recommended by advisers to many fixed income investors, as they venture further out on the risk spectrum in the current sustained low-interest-rate environment. See High-Yield Bonds.

In the week of March 4th alone, investors bought $820 million of junk-bond mutual funds and exchange-traded funds, reversing a four-week trend in which money flowed out of junk bond funds, according to “Yields for ‘Junk’ Resume Descent,” by Patrick McGee of the Wall Street Journal, citing data from Lipper FMI.

Junk bonds are said to be more closely correlated with stock prices than bond prices. Thus, the junk bond rebound was likely spurred by signs of an improving U.S. economy, which lifted the Dow Jones Industrial Average to record highs recently, as well as statements by Federal Reserve Chairman Ben Bernanke that Fed bond buying would continue.

Likewise, the volatility of junk bonds is similar to stocks. Junk bonds also present an increased risk of default compared with investment-grade bonds. Illiquidity may also become an issue if interest rates rise sharply, sending bond prices sharply lower.

Nevertheless, investor demand has encouraged a wave of junk bond offerings from companies who could not otherwise borrow so cheaply. Such companies have already sold $78 billion of bonds this year, compared with $79 billion sold for all of 2012. Heavy demand has also allowed lower rated companies to offer fewer investor-friendly covenants, which, for example, limit the total amount of debt companies can issue.

Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.