You need only follow the money flowing into junk bonds to see how investors are reaching for yield. Over the 16 month period ending in April investors added $8.8 billion to junk bonds—$5.4b of that was added in the first four months of this year. Meanwhile the yields investors are reaching for are at some of the lowest levels in recent history. The spread between junk bonds and U.S. Treasuries was only 3.4 percentage points in April, a post-financial-crisis record according to Barclays, but still higher than the 2.32 percentage point low set in 2007.
Investors need to know that junk-bonds can blow-up in a good economy. “The high-yield market has a history of producing default cycles that aren’t necessarily predicated on big shocks to economic growth,” said Michael Hong, of Wellington Management Co., who runs the $16.9 billion Vanguard High-Yield Corporate fund. But investors seem to be oblivious to the potential pitfalls in junk bonds. “The average yield on bonds in the Barclays U.S. corporate high-yield index is 5.1%, recently flirting with the record low of just below 5% reached in May 2013, ” writes Tom Lauricella in the WSJ. You don’t want to participate in this record.
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