Getting into corporate bonds isn’t easy.
“It’s practically impossible for the average investor to build a diversified portfolio of corporate high-yield bonds,” says Nicholas Leach, vice-president of global fixed income, high yield at CIBC Asset Management.
“Many of these bonds are non-registered, and are therefore restricted to qualified institutional buyers only. In fact, virtually all new issues in the primary market are only available to qualified institutional buyers, so the retail investor is really shut out,” he says.
Even if a retail investor is able to buy corporate bonds, properly diversification is another challenge.
“A portfolio should have at least 75 securities to mitigate company-specific credit risk, and high yield bonds are traded in round lots of 1 million to 500,000,” says Leach. “Smaller, odd lots are available, but they carry much higher transaction costs. So, a properly diversified portfolio of high-yield bonds could require tens of millions in capital.”
In addition to a large capital base, “The most important element of investing in the high yield space is credit analysis. That requires a team of dedicated professionals on a full-time basis,” says Leach.
That team examines companies from a bottom-up basis, says Patrick O’Toole, vice-president of global fixed income, active bonds at CIBC Asset Management. “[We also] look at things like central bank policy, government budgets, the political environment — these give us a sense of where our interest rates are going.”
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Since retail investors don’t have those resources, O’Toole stresses it’s difficult for them to go it alone: “We’ll tend to see new issues or secondary offerings much sooner than the average retail investor does. We also get different pricing. In an over-the-counter market, the price is whatever the dealer and you negotiate. So being a large institutional investor, we buy bonds from 10 million a time up to 100 million at a time.”
What to buy
One strategy is getting into the crossover space, “where companies are really right on the verge of being upgraded to investment grade,” Leach says. “[We] look for companies that look and feel like investment-grade companies, but are actually rated non-investment grade. There we pick up extra yield without taking on too much incremental credit risk.”
O’Toole says the extra work to manage corporate bonds is worth it. “The yields available in corporate bonds are still fairly attractive relative to government bonds. It doesn’t mean you’re going to win every quarter, but over the medium and longer term, corporate bonds will continue to outperform government bonds.”