Investing in non-financial companies allows for increased diversity in the high-yield bond market.
You can’t get that in the normal bond market, says John Braive, vice chairman of CIBC Asset Management. He co-manages the Renaissance Real Return Bond Fund, Renaissance High-Yield Bond Fund and Renaissance Canadian Bond Fund.
“We like the diversification we get by industry, the types of [companies] we’re buying and the fact we’re getting good yield pick up over the curve,” he adds.
Not to mention, “When you put [this] together with reduced risk and the extra yield, you’re going to be ahead by owning junk bonds as compared to government bonds or investment-grade corporates.”
Higher yield of course equals higher risk, but that’s why these companies have to pay more to borrow money.
And when comparing investment grade to high yield, says Braive, there’s a big difference.
Default risk for a triple-A security is zero, he explains. It starts to move higher as you get lower in the credit rating. If you look at high yield, the default risk is historically between 5% and 7%, but it was as high as 14% in 2008.
For the last year, however, it’s been sitting at a low 3.5% for high-yield bonds.
And remember: when a company defaults, you have the right to the assets as a bondholder, says Braive. There’s usually a recovery of 50%-to-60% of the value of the security.
He also warns investors to watch for companies that are in struggling businesses. For example, Yellow Media bonds are down in value, he says. This is the company that used to publish the Yellow Pages.
“They cease payments on the interest,” says Braive. “Their platform is one that’s very difficult. Anything that’s print is very suspect as to how long it can actually last in a world where everything is going digital.”
He avoids newspapers, as well as media companies that rely on print publications. He also uses a scorecard when reviewing high-yield bonds.
First, he looks at the industry, then at the company and its financials. Finally, he considers the relative spread versus other securities. Each factor is assigned a green, yellow or red light.
Braive says, “We [either] say there’s enough green and yellow here for us to approve it, or there’s too much red and we can’t process the approval of this credit. We go through a lot of due diligence on everything that we put in to the funds.”