Junk bond attraction
The Junk bond attraction could make sparks fly, bearing in mind that the high-risk high reward nature of the high-risk debt market makes junk bonds attractive. All the stars are aligning for a junk bond attraction that could be like none other.
Investors have been building up cash position in anticipation of a market correction and the end of the credit cycle. Indeed, the Fed, the world’s central bank by default is showing no indication, under the new Fed Chairman Jerome Powell, that it will abandon its normalization policy.
The Junk bond attraction is about spotting high yielding corporate bonds which are likely to survive in a climate when credit becomes more expensive. So the era of cheap credit is coming to an end and so too are zombie companies which survived on an artificial life support of cheap credit.
So what then is this junk bond attraction?
First, let’s define a junk bond. A junk bond refers to high-yield or noninvestment-grade bonds. Junk bonds are fixed-income instruments that carry a credit rating of BB or lower by Standard & Poor’s, or Ba or below by Moody’s Investors Service. Junk bonds are so called because of their higher default risk in relation to investment-grade bonds.
Put simply, the junk bond attraction is based on the potential of high investor rewards with the downside being that the investor’s capital is being put a risk. When a company defaults the outcome for the investor is that he/she could lose all the capital invested to the value of their junk bond investment.
So the junk bond attraction can be a bit like the carnivorous plant, venus fly trap.
Junk bond attraction can be fatal. But that is the risky part of junk bond investing and now let’s look at the potential reward. Junk bond attraction of making high returns is based on sporting high yielding corporate bonds which are likely to survive a normal interest rate environment and a global economic slowdown in this new era of trade protectionism.
So-called smart money is licking its lips and getting ready to load up on distressed debt
This is defined as junk-rated bonds yielding at least 10 percentage points above equivalent US treasury.
“As corporate indebtedness in the US has reached precarious heights, and as risks are piling up, in an environment of rising interest rates and a hawkish Fed, the smart money is getting ready,” wrote Richter.
So the junk bond attraction is that distressed-debt investors can “make a killing by buying bonds for cents on the dollar during times of economic stress.”
But investors also need to keep their optimism in check. There is also a risk that the investment they are making in the company may not survive the credit squeeze. The junk bond attraction is a high-risk high reward play.