What Are High Yield Bonds?
High yield bonds are corporate securities with credit ratings below investment grade. To attract investors, non–investment grade companies usually pay higher interest rates than issuers deemed to be more creditworthy, so their bonds are called “high yield.” High yield bonds can be used to diversify an investment portfolio because their performance has a low correlation with most asset classes, especially investment grade bonds such as Treasuries and high grade corporate debt. Like stocks, high yield bond prices are more sensitive to the economic outlook and corporate earnings than to day-to-day interest rate fluctuations. While high yield bonds share some behavioral characteristics with stocks, their overall returns should be less volatile because their income is generally much higher.
Credit analysis is central to high yield bond investing. It focuses on individual characteristics and fundamentals of issuers as well as the downside risk of default. The broad high yield market is diversified by industry group and issue type. Today’s vast global high yield market can enable portfolio managers to achieve extensive diversification by region, industry and issuer, as well as by the individual issue within a firm’s capital structure. By actively managing portfolios, PIMCO seeks to lower portfolio volatility while enhancing returns.
The PIMCO High Yield Spectrum strategy deploys PIMCO’s proven, bottom-up security selection across the entire range of global high yield debt – including securities of all speculative rating levels, all regions and non-U.S.-dollar-denominated high yield corporate bonds – to seek enhanced returns and meaningful portfolio diversification. The strategy’s emphasis on active security selection via thorough, independent credit research and analysis is vital to targeting compelling opportunities across all economic and market environments, while attempting to minimize the downside risk associated with a downgrade or default.
The principal reasons for investing in a broad opportunity set of high yield bonds are diversification and the potential for superior risk-adjusted returns over a full market cycle. High yield bonds have typically had a low correlation with most other fixed income sectors, which may enhance the risk/return profile of a broader core fixed income portfolio over the long term. Additionally, high yield bonds have a similar return profile to equities but generally significantly lower volatility.
PIMCO’s philosophy and approach to the high yield market is consistent with our conservative, yet innovative, approach toward the fixed income markets in general. Specifically, our High Yield Spectrum global fixed income philosophy embodies five key principles:
PIMCO’s High Yield Bond Experience
PIMCO started using high yield bonds as a key component in our sector rotation process in the 1980s. We introduced our first high yield commingled vehicle in 1992, which focused on the upper quality tiers of high yield. In 1998 we began managing portfolios across the full high yield quality spectrum. We have an experienced team of high yield portfolio managers and credit analysts, each of whom focuses on credit analysis for certain industries. The team’s disciplined and dynamic credit selection process emphasizes each security’s fundamentals, while also incorporating insights from PIMCO’s long-term macroeconomic outlook.
PIMCO’s experienced team of credit analysts, located around the globe, is responsible for evaluating and rating every corporate credit in our portfolios. Independent analysis is critical when evaluating corporate credits and we never rely on rating agencies alone. Our research is focused on issues with improving credit profiles and prospects for rating upgrades and, therefore, greater capital appreciation potential. A prerequisite to our evaluating an issuer is access to management. We concentrate on issuers we feel have strong underlying businesses and competitive positions.
Default and spread widening risk are the dominant potential risks in purchasing high yield corporate debt. Our focus on the comprehensive evaluation of credits, both at purchase and on an ongoing basis, focused on reducing the risk of downgrade or default
Credit decisions begin with an analysis of the country’s underlying credit fundamentals and capacity for long-term economic growth. Those results are augmented with an analysis of the potential impact of external economic conditions and technical conditions of each country. Corporate credits are then analyzed within the framework of the country analysis, to help identify and capture differences in the business cycles across countries.
Industry analysis represents another important aspect of the bond selection process. The credit analysts and portfolio managers work together to identify industries that are undergoing structural or competitive changes that will affect profits and cash flow.
Fundamental, company-specific credit analysis forms the most critical stage of our corporate credit research process. The team of credit analysts is organized by industry in order to facilitate company evaluation across the ratings spectrum, providing for the identification of relative value opportunities within industries. For each company, the analysts assign a rating to identify the level of intrinsic credit risk, based on the company’s financial condition, the feasibility of its strategic plan, the quality of management, as well as other quantitative and qualitative factors.
PIMCO’s robust, top-down macroeconomic analysis of the world’s major economies sets the tone for the structure of our global credit portfolios. The assessment of the direction of global economic growth and interest rates provides important insight in choosing the optimal portfolio structure and sector allocation within this strategy.
High yield securities are subject to greater levels of credit and liquidity risk than other securities. High yield bonds are considered predominately speculative with respect to the issuer’s continuing ability to make principal payments. An economic downturn or period of risk aversion could adversely affect the market for high yield debt and reduce an investor’s ability to sell its securities.
In addition to PIMCO’s disciplined approach to fundamental credit research, extensive analytical tools are used to measure and monitor the risk characteristics of the portfolio. PIMCO has invested considerable resources in developing proprietary models and analytical tools that enable a robust approach to risk management. These tools are important in managing credit strategies as their flexibility facilitates analysis at the regional, sector and security level. These models include our Bonds Under Management report, which provides an extensive summary of portfolio holdings and portfolio-level risk characteristics. Additionally, the PIMCO Position Blotter system provides risk and portfolio structure information, allowing for the aggregation of detailed security-level information into a variety of risk matrices including sector and issuer exposure by quality and duration bucket.
Extensive use of analytical tools helps allow us to maximize the value of our investment professionals and provides a dispassionate check on our investment decisions. These systems also augment our understanding of the strategies that have consistently added value to our clients’ portfolios.
Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. High-yield, lower-rated, securities involve greater risk than higher-rated securities. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. PIMCO strategies utilize derivatives which may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. There is no guarantee that this investment strategy will work under all market conditions and each investor should evaluate their ability to invest for a long-term especially during periods of downturn in the market. Diversification does not ensure against loss.
The correlation of various indices or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility.
This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2013, PIMCO.
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