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Some High-Yield Managers Are Making Bolder Bets

The lowest-rated bonds appear to be trading in more dangerous territory lately.

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Not all junk-bond investing is created equal. BB rated debt sits at the top of the below-investment-grade credit-quality rating spectrum and carries the lowest relative credit risk. As you move down the credit-rating rungs, the default rate at each sequential rung increases exponentially. According to data from S&P Global Ratings' "2020 Annual Global Corporate Default And Rating Transition Study," the global corporate annual default rate for issuers rated BB was 0.93% last year, compared with 3.5% for issuers rated B and a whopping 47.5% for issuers rated CCC, CC, and C. This phenomenon contributes to the persistent compensation (yield) differences offered at each rating tier, which is particularly acute during times of credit market stress.

Credit spreads--the additional yield provided for taking credit risk beyond that of U.S. Treasury bonds--jumped during 2020's first-quarter volatility. The chart below reflects the ICE BofA U.S. High Yield Index's option-adjusted spread, which measures its spread over a spot U.S. Treasury curve. It jumped to 8.8 percentage points as of March 2020 from 3.6 percentage points as of December 2019. Over the same stretch, the ICE BofA CCC & Lower U.S. High Yield Index's option-adjusted spread spiked even higher, soaring to 17.9 percentage points from 10.1. With the ensuing rebound, credit spreads have narrowed further than where they rested prior to the broad market sell-off in 2020's first quarter. The broader high-yield benchmark's option-adjusted spread tightened to 3.4 percentage points as of March 2021, while the riskier bogy has come down well below 2019 levels to 6.6 percentage points. 

R.J. D'Ancona does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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