There has been a marked uptick in purchases of high-yield or junk bonds by retail investors. Junk bonds pay a higher interest rate to compensate investors for the increased risks of default, among other risks. So far this year, retail investors are have put $11.8 billion into junk bond mutual funds, $9.9 billion into investment grade bond funds, and $4.8 billion into stock funds (See Wall Street Journal, “Buyers Take a Shine to ‘Junk'”). Mutual fund managers are also buying more junk bonds to enhance returns.
Many junk bond investors are simply seeking to earn a reasonable yield on their investments and do not understand the zero-to-very low yield on investment grade debt. They are afraid of other high yield products having been warned by the Financial Industry Regulatory Authority about the risks, complexities and illiquidity of alternative (non-conventional) investments, such as hedge funds, nontraded REITs and structured products.
Unfortunately, most junk bond investors are taking far more risk than they suspect. The junk bond market is speculative and high-risk. The junk bond market is also made more volatile by hedge funds and exchange traded funds.
Simply stated, junk bonds and junk bond funds are risky assets. Risky assets normally do not respond well to uncertainty, and there is plenty of uncertainty with the European sovereign debt crisis, rising gas prices, and saber-rattling in the middle east. Investors and their advisers should be cautious about putting money into risky assets.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.