Portfolio risk diversification
High-yield notes are often considered a separate asset class, involving different characteristics from those of other securities such as investment grade notes. Investors seeking the potential higher income from high yield corporate notes often must assume significantly higher risks associated with these securities. Therefore, high yield notes typically comprise a relatively small portion of an overall portfolio.
High-yield notes can help investors spread assets across different segments of the financial market, reducing risk concentration in any one asset class in an overall portfolio. In most cases, however, there are higher risk factors associated with high yield notes, such as higher levels of credit risk and adverse corporate events. As a result of these increased risks, many financial advisors recommend a smaller portion of assets dedicated to high-yield notes relative to investment grade notes.
Enhanced current income
A yield premium for high yield corporate notes can particularly attractive during periods of declining interest rates. Investors focus on the difference between yields on high-yield notes and the yields on U.S. Treasuries or other issues of comparable high credit quality. This difference - called a “yield spread” - has typically been about 250 to 700 basis points (2.5% to 7.00%) for securities of comparable maturities. Investors should be prepared to accept the tradeoff of higher yields for increased risks for the percentage of a portfolio allocated to high yield securities.
Capital appreciation potential
Positive events in the economy, industry or issuing company can reward you with increases in your high-yield note's price, otherwise known as capital appreciation. These events include ratings upgrades, improved earnings reports, mergers or acquisitions, positive product developments or market-related events.
Security
If a company is liquidated, bondholders usually have priority over stockholders in a company’s capital structure. The percentage of this payment compared with the original investment is called the “recovery rate.” As described in Types of Corporate Notes, the holders of “secured debt” and “unsecured senior debt” have the highest claim on corporate assets in a bankruptcy distribution. In most bankruptcy distributions, the holder of a low-rated notes may be entitled to a share of a failing company’s assets ahead of preferred or common stockholders.
Less interest rate volatility risk than long-term bonds
Prices of all market-traded fixed-rate bonds are affected by interest rates. If rates move up, bond prices move down (and vice versa). In general, the longer a bond’s maturity, the more vulnerable its price is to interest rate fluctuations. High-yield bonds are typically issued with maturities of 10 years or less, and can be callable prior to maturity. This can result in reduced interest rate volatility relative to longer term debt instruments.
Total return performance
The “total return” performance of high-yield notes includes price changes and reinvested interest income. Although high-yield notes carry a risk of default, in general they tend to produce attractive total returns when the economy is growing and interest rates are stable or declining.
Please consult your financial advisor and relevant offering documents prior to investing any money in these or other products, and for information and additional risks associated with High-Yield Corporate Notes, including but not limited to, call risk, principal risk, credit risk and interest rate risk. These products are offered through many but not all broker-dealers.
This information does not constitute an offer to sell or a solicitation of an offer to buy the securities, nor shall there be any sale of those securities, in any state or jurisdiction in which such an offer, solicitation or sale would be unlawful. Product suitability must be determined for each individual investor.