High-yield debt investing: Limiting high-yield debt to 10-25% of your fixed income portfolio

Yield Enhancement:

The primary draw of high-yield debt investing is the potential for higher yields. In an era where traditional fixed-income options are offering lower returns, high-yield bonds are an attractive avenue for income generation.

Opportunities in Economic Expansion:

During periods of economic expansion, high-yield investments may thrive. As companies improve their financial positions, the risk of default among high-yield issuers can decrease, potentially offering an opportunity for investors to benefit from improving creditworthiness.

Diversification:

Including high-yield bonds in a diversified portfolio can provide additional diversification benefits. These bonds may exhibit different market behaviors than other fixed-income options, contributing to overall portfolio stability.

Default, Liquidity & Volatility Risk:

Issuer company health is crucial in high-yield debt investing because it directly impacts the likelihood of the issuer meeting its debt obligations. Assessing the company's health helps investors gauge credit risk, understand business stability, and make informed decisions in a market segment known for higher default risk and volatility. Limited marketability and increased price fluctuations can make it difficult for investors to buy or sell these bonds at favorable prices, especially in times of market stress.

Weaker Contract Protections & Credit Downgrades:

High-yield bonds often lack robust contract protections, jeopardizing bondholders' interests during financial distress. Companies issuing such debt face elevated credit downgrade risks, potentially forcing investors to sell bonds at reduced prices or hold securities with a heightened risk of default.

Portfolio Construct:

Retail investors, and even HNI investors with a portfolio size less than Rs 15 crore should avoid investing in these instruments as they are often more suitable for sophisticated investors with a higher risk tolerance.

Limiting high-yield debt to 10-25% of the fixed income portfolio basis risk profile is a prudent approach to managing risk as it allows for potential higher returns associated with high-yield investments while maintaining a balance to mitigate the impact of increased volatility and default risk.

To conclude, there is no doubt that high yield investing is a double-edged sword. Though it offers potential enhanced returns, it also exposes investors to multiple risks.

Investors could mitigate at least one risk by Buying high-yield debt products from established/reputed wealth management firms or investing through managed funds that have the ability to provide investors with professional expertise, risk management, and access to diversified portfolios, thereby enhancing the overall quality and security of their investment.

(The author is the CEO & MD, ASK Private Wealth)

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)