My Warning On High-Yield Corporate Debt Investments

BBB-rated debt is the lowest-quality debt that is considered “investment grade.” Anything below that is what we call “junk debt” or “junk bonds.” BBB-rated debt can be worrisome because it actually shows up in the portfolios of American pension funds, endowments, charitable trusts, and high-yield bond funds like the Fidelity Capital & Income Fund, Vanguard High-Yield Corporate Fund, Blackrock High-Yield Fund, and Blackrock High-Yield Bond Fund. 

In 1980, BBB-rated debt accounted for 8% of fund offerings.

In 1990, BBB-rated debt accounted for 18% of fund offerings.

In 2000, BBB-rated debt accounted for 23% of fund offerings.

In 2010, BBB-rated debt accounted for 37% of fund offerings.

In 2019, BBB-Rated debt accounted for 52% of fund offerings.

And these are only the figures for the United States. If you count “global high-yield bond funds”, over 53% of it as classified as junk-bond status.

This is problematic for several reasons. First, investors in high-yield corporate debt are now buying lower-quality assets and accepting lower annual income than their predecessors did. Second, BBB is the bottom of what is permissible for many institutional funds to own. If and when BBB-rated debt is downgraded to junk status, many of the fundholders are obligated to sell the debt per the terms of its operating documents that permit it to own no asset worse than BBB-rated. And third, we are more than a decade removed from a recession, so being BBB-rated right now in 2019 is an insult compared to a business carrying this label in 2009.

It is crazy to think that half of fund offerings for high-yield debt. If there are downgrades in rapid succession for any BBB-rated companies, there could be a massive sell-off as a required matter of course. If someone wants to be savvy in this market, wait for something like General Electric or Kraft-Heinz to see their debt downgraded to junk status (if that happens), and then you can buy low while forced selling occurs. But otherwise, I would stay out because there are strong institutional considerations that tie the hands of bond managers and half of their assets are now dedicated to debt that is one downgrade away from forced selling. It is an area where modest declines could produce outsized investment harms. 

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