Note: this chart has been updated on 12th August 2016 to bring it up to date. Article originally published on 9th December 2015.
In today’s low growth, low interest rate environment generating a sufficient level of income from investments can prove tricky. With bank deposits paying next to nothing and traditional income paying assets such as equity income funds not always able to deliver the amount of income investors require, people may need to look further afield in order to identify good income sources.
With this in mind we have identified three alternate sources of income which investors should consider. So far we have looked at infrastructure and commercial property. In the third part of the series we take a look at high yield.
High yield
High yield bonds are the part of the corporate bond market given a classification lower than BBB, as highlighted below. They are sometimes referred to as ‘junk bonds’ but this less than glamorous moniker belies their potential.
Below are the different classifications and where high-yield bonds fit in:
Investment grade
- AAA and AA: UK Government, large quality companies investment grade
- AA and BBB: Medium credit-quality investment grade
Non-Investment grade (high yield)
- BB, B, CCC, CC, C: smaller companies and Low credit-quality
- D: in default for non-payment of principal and/or interest
Their lower rating means they tend to have a higher risk of default but at the same time they can offer a higher level of income. High-yield default rates, though, have been low over the last few years and yields have recently risen to attractive levels.
Different characteristics
High yield bonds have some different characteristics to other parts of the bond market, according to Kames Capital.
High yield returns have low correlation to government bond returns, and given this characteristic, tend to behave more like equities, but with moderately less risk. High yield bonds tend to perform well when interest rates start rising; something that might interest investors now the US Federal Reserve (Fed) looks set to raise the base rate later in December.
Sweet spot
AXA Investment Managers, which runs the AXA Global High Income fund, notes that:
- Due to high yield’s low correlation with other fixed income asset classes, an allocation to global high yield bonds can also improve the risk/return profile of fixed income portfolios.
- Global high yield spreads (the difference in yield between corporate bonds and their equivalent government-issued bonds) remain at historically high levels which gives AXA comfort that high yield continues to be an attractive place to look for income.
- We are currently at the recovery or expansion phase of the economic cycle, with interest rates very low, which AXA points out is typically the “sweet spot” for high yield.
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Past performance is not a reliable indicator of future results
Source: Bloomberg. All returns in GBP.
High yield bonds are high-risk investments and are intended for individuals with an appropriate degree of trading knowledge and experience.
AXA Global fund and Kames High Yield fund are both on our recommended list. You can find out more information about each of them below or click on one of the graphs for a more detailed look.
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