High yield bond funds
What are high yield bond funds?
As the name suggests, high yield bond funds generally seek to offer higher returns than other types of bond funds by investing primarily in high yield bonds or debt securities which are below investment grade (sometimes referred to as junk bonds), unrated debt securities, distressed and/or selective default debt securities.
Issuers of these bonds and/or debt securities are generally subject to higher credit or default risk. The net asset value of a high yield bond fund may suffer significant decline when there is a default of any of the high yield bonds and/or securities in which it invests. Your investments in the high yield bond fund will, as a result, be adversely affected and you may suffer significant losses. As such, high yield bond funds are usually considered to be risky investments.
It is also common for high yield bond funds to make regular distribution to investors and such distribution may be paid out of capital. Distribution out of capital may amount to a return or withdrawal of part of an investor's original investment. This in turn will reduce the fund's capital available for future investment.
How can I know whether a bond fund is a high yield bond fund?
You should not simply rely on the name of a fund in determining whether it is a high yield bond fund. You should refer to the offering documents to understand the investment objectives and strategies of the fund, as well as the nature and risks of its underlying investments.
If a significant portion of the underlying investments of a fund includes one or more of the following types of debt securities, it is likely that the fund is a high yield bond fund:
- below investment grade securities which are sometimes referred to as "junk bonds" (e.g. below BBB- for Standard & Poor's or below Baa3 for Moody's);
- unrated debt securities;
- high yield instruments issued or guaranteed by corporate or sovereign issuers that are unrated or below investment grade;
- distressed securities (i.e. securities issued by a company that is in financial difficulty or in default); and
- selective default securities (i.e. securities rated as such by credit rating agency where the issuer has selectively defaulted on a specific issue or class of obligations but will continue to meet its payment obligations on other issues or classes of obligations in a timely manner).
Some high yield bond funds may invest in convertible bonds and/or structured products with underlying exposure to fixed income securities e.g. mortgage backed securities or asset backed securities.
What are the key risks associated with high yield bond funds investment?
Given high yield bond funds will primarily invest in bonds with higher default risk and lower or without credit rating, you should therefore note that the risks of investing in these funds are very similar to those of the underlying investments. Some key risks specific to high yield bond funds investment are set out below:
Higher credit/default risk:
- Investing in below investment grade bonds and/or unrated bonds may be subject to a higher default risk than investing in investment grade bonds. An issuer of high yield debt securities may be highly leveraged and the issuer's ability to meet its debt obligations may be adversely affected by the issuer's business and financial conditions or unavailability of additional financing.
- If the issuer defaults, or the below investment grade bonds or other underlying assets cannot be realised, you may suffer substantial losses by investing in the high yield bond funds.
Higher liquidity risk:
- The market for below investment grade bonds or unrated bonds generally has lower liquidity. As a result, a high yield bond fund may not be able to purchase or liquidate its holdings in response to changes in the economy or the financial markets. This in turn may have an adverse impact on the value of the fund.
Higher volatility risk:
- Investments in below investment grade or unrated bonds involve greater price volatility. These types of bonds are more sensitive to adverse changes in general economic conditions and financial conditions of the issuers. As such, the risk of loss of principal and income is much higher than investing in investment grade bonds.
Risk of distribution out of capital:
- In order to ensure and maintain a high distribution rate as well as a regular income stream for investors, a lot of high yield bond funds may pay dividends out of capital or gross income and/or charge / pay all or part of the fund's fees and expenses to / out of capital. This amounts to a return or withdrawal of part of an investor's original investment or from any capital gains attributable to that original investment, and may result in an immediate reduction of the net asset value per unit of the fund.
- You should therefore be aware that high distribution yield of a fund does not imply a positive or high return on your investments. In addition, there is no guarantee of a dividend payout or the dividend rate for these high yield bond funds.
Derivative instruments risk:
- A high yield bond fund which uses derivatives (such as futures, options and swaps etc.) for hedging or enhancing return is subject to additional risks associated with these derivative instruments. These risks include market volatility risk, credit risk, counterparty risk, liquidity risk, valuation risk, leverage risk as well as the default risks of the derivatives' issuers.
Apart from the above key risks, what other additional risks should I be aware of ?
You should be aware of any other key risks relating to the relevant high yield bond fund, for example, concentration of investments in particular types of specialised debts or specific geographical region (like emerging markets) or sovereign countries.
For instance, a high yield bond fund investing significantly in distressed securities is subject to higher credit or default risk. There is no guarantee that any reorganisation or restructuring plan in respect of the securities issuer will be accomplished and this in turn may have a negative impact on the value of the high yield bond fund. In addition, depending on how the underlying bonds invested by a high yield bond fund are structured, the fund as the bondholder may be ranked after senior lenders if the bond issuers become insolvent.
A high yield bond fund with investments concentrating in emerging markets also tends to be more volatile and involves, amongst others, a greater exchange rate risk and this may negatively affect the value of the fund in a significant way.
You should also note that investing in high yield bond funds is not the same as placing deposits with a bank and there is no guarantee of the repayment of principal. If the underlying investments of the high yield bond funds incur losses, the value of the funds will be adversely affected and you may also suffer losses in your investments in the funds.
In addition to the key risks specific to high yield bond funds, you are also reminded to take note of the general risks associated with investments in bonds. Such risks include interest rate risk and exchange rate risk etc. You can refer to the article "Key Risks" of the bonds section for more details about the general investment risks of bonds.
How do I choose a high yield bond fund and where can I get the relevant information?
As with any other kind of investments, you should first make sure that you fully understand the investment objectives, strategies and distribution policy of a high yield bond fund and the types, nature and risks of its underlying investments.
The fund's offering documents, including the product key facts statements, provide you with a lot of information about the investment objectives and strategies, risks factors, asset allocation and dividend policy of the fund.
You are advised to check out with your intermediary as to whether a fund is really suitable for you before making a commitment. You can find the offering documents of funds authorised by the SFC by searching the List of Investment Products on the SFC's site.
If in doubt, please seek professional advice.