Today’s High-Yield ‘Junk’ Bonds Aren’t Necessarily Junk

In a yield-starved environment, investors are looking for bonds that pay more, and high-yield bonds, also called “junk” bonds, may be quite appealing to some.

Many years ago, a group of credit rating agencies (Moody’s Investor Service, Standard & Poor’s, and Fitch Ratings) developed a system to “grade” the relative credit quality of bond issuers. The highest-quality bonds are rated AAA, and the credit scale descends to D (for default).

Subsequently, many financial institutions restricted their investments to the highest-rated bonds, called investment-grade bonds. Lower-rated bonds, meanwhile, developed a negative connotation and soon became known as junk bonds.

But junk bonds aren’t necessarily junk. Over time, many investors have discovered that the risk-adjusted returns for junk bonds were high, and they began to buy them. Indeed, junk bonds tend to be particularly appealing when yields on other bonds are low, as they are today, when the U.S. Federal Reserve Board is opting to keep interest rates low. In fact, it may be more accurate to call them high-yield bonds instead of junk bonds.

Of course, while high-yield bonds may pay higher yields than investment-grade bonds, they may also have higher volatility and higher risk of default. While no investment is ever totally safe, portfolio managers try to minimize these risks by using credit analysis to evaluate the possibility of a bond issuer’s default. And they diversify their portfolios, which can help balance the ups and downs of individual bond prices; some might perform poorly, while others might be performing well.



How Our Rising USD Affects Your Investments

Recently, the U.S. dollar has been on a roll: The U.S. Dollar Index (which measures the value of the greenback against the euro, Japanese yen, Canadian dollar, British pound, Swedish krona, and Swiss franc) reached a four-year high in the third quarter of 2014.

Good news in some ways, but what does it mean for your investments?

A rising dollar makes U.S. exports more expensive. That’s because American exporters sell their goods in foreign countries and are paid in a foreign currency that is now falling relative to the U.S. dollar. Their profits are thus lower, and their stock values could fall.

Alternatively, when the dollar rises against other currencies, imports are less expensive.

That’s because importers buy goods in a foreign currency that’s falling relative to the U.S. dollar, so they can pay less to obtain goods than they did previously. That could increase the profits of importers, which could drive their stock prices higher.

A soaring U.S. dollar can also detract from the returns on your foreign investments. Foreign stocks are bought and sold in local currency, meaning U.S. mutual funds and other such products must convert U.S. dollars to a local currency in order to make a purchase.

Then, when selling, the fund must exchange the proceeds for U.S. dollars.

As an example of the impact of currency fluctuations, consider that in 2013, Toyota Motor Corporation stock returned 63.1 percent in Japanese yen, but only 33.4 percent in U.S. dollars. That was because the U.S. dollar strengthened against the yen in 2013. U.S.-based investors lost more than 47 percent of the stock’s return in the exchange rate.

The U.S. Dollar Index’s third-quarter gain was its second-largest quarterly rise since the inception of the euro in 1999.

So keep a weather eye on the dollar, and contact your advisor if you need more information on your investments and our high-flying buck.