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Corporate bond labels don’t always accurately represent the quality of bonds, especially when it comes to the high-yield market.

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“High yield [is] misunderstood by many investors today,” says Nicholas Leach, vice-president of global fixed income and high yield at CIBC Asset Management. He’s the lead manager of the Renaissance High-Yield Bond Fund.

“And that’s largely because of the junk label,” he adds. “[That label] creates this big misconception that the high-yield market [consists of] a bunch of troubled companies on their way to bankruptcy. And that’s simply not the case today.”

Since the mid-1980s, he explains, the high-yield market has undergone many changes, “Prior to the ’80s, it was mostly fallen angels or former investment-grade companies that got themselves into trouble. And there really was no primary market to speak of.”

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But, over the last 25 years, the market has expanded from $100 billion to almost $1.4 trillion, says Leach. “That $1.4 trillion includes a lot of great companies with iconic brands that you’d be surprised to find in the space.”

Further, even though there are bad apples that are easy to identify, Leach says there are also companies in the market have been improperly rated, he adds. “You’ll find a lot of bonds out there that trade at a discount to their actual credit quality. Valeant Pharmaceuticals has an $88-billion equity cushion behind [its] bond holders, so it deserves an investment-grade rating.”

Read: Winners in the corporate bond space

Leach says HCA Healthcare and T-Mobile are two of his top credit picks in the high-yield market. “[HCA] is one of the largest hospital companies in North America: it has a $31-billion market cap as an equity cushion for bond holders. And, T-Mobile is the fourth-largest wireless carrier in North America—it has 43 million subscribers, and that’s almost double the size of Rogers, Telus and Bell combined.”

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To analyze mislabeled high-yield bonds, Leach focuses on “identifying [companies] with the look and feel of investment-grade companies, but that don’t have investment-grade credit ratings.”

Read: Offer global perspective on bond yields

He finds the reason credit-rating agencies are less diligent in rating some high-quality, high-yield bonds is because of their own reputational risk. “There’s a huge amount of risk on the line if an investment-grade bond is [improperly] rated, but there’s not [as] much risk associated with [improperly] rating a high-yield company.”

Read: Going global in bonds

As a result, many companies’ ratings often become outdated. “This creates some inefficiencies [in bond markets] because there are a lot of investors that tie their passive investment strategies to [bonds’] ratings. But, this creates opportunities for active investors that do their own credit research.”

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Note: Advisor Group is a division of Rogers Communications, Inc.

Originally published on Advisor.ca

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