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Staying defensive in the junk bond market

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For some, the idea of the “junk bond” market might conjure up thoughts of bold risk-taking where portfolio managers make big bets on troubled companies in an effort to earn outsized returns. In reality, seasoned high yield investors understand that the key to achieving outperformance in the world of below-investment grade corporate debt largely involves avoiding losers rather than picking winners.

In the uncertain world of the coronavirus, even with several vaccines on the way, avoiding excess risk is more important than ever. As a result, one might assume that relatively higher quality issuers would trade at a premium over those with lower quality balance sheets as investors vie to own the highest quality assets. Surprisingly, however, today higher quality assets arguably look cheap when compared with riskier issuers relative to historical averages. Consequently, and given the context, having a defensive mindset within high yield makes more sense than ever. Luckily, for investors looking to play it safe, the opportunity set in the high yield market is greater than ever and likely growing.
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The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results.

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A word on risk
Investing involves risk; loss of principle is possible. There is no assurance that downside protection will be achieved.
Credit risk may be heightened for the portfolios that invest a substantial portion of their assets in “high yield” debt or loans with low credit ratings. These securities, while generally offering higher yields than investment-grade debt with similar maturities, involve greater risks, including the possibility of interest deferral, default or bankruptcy, and are regarded as predominantly speculative with respect to the issuer’s capacity to pay dividends or interest and repay principal. Companies that issue high yield debt or loans tend to be highly leveraged and thus are more susceptible to the risks of interest deferral, default and/or bankruptcy.

Securities of below investment grade quality are regarded as having predominately speculative characteristics with respect to capacity to pay interest and repay principal, and are commonly referred to as junk bonds. Issuers of high yield securities may be highly leveraged and may have fewer methods of financing available. The prices of these lower grade securities are typically more sensitive to negative developments, such as a decline in the issuer’s revenues or a general economic downturn, than are the prices of higher grade securities. The secondary market for high yield securities may not be as liquid as the secondary market for more highly rated securities, a factor which may have an adverse effect on a portfolio’s ability to dispose of a particular security. There are fewer dealers in the market for high yield securities than for investment grade obligations. The prices quoted by different dealers may vary significantly and the spread between the bid and ask price is generally much larger than for higher quality instruments. Under adverse market or economic conditions, the secondary market for high yield securities could contract further, independent of any specific adverse changes in the condition of a particular issuer, and these instruments may become illiquid. As a result, a portfolio could find it more difficult to sell these securities or may be able to sell the securities only at prices lower than if such securities were widely traded.

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This information does not constitute investment research as defined under MiFID.