A Primer on Junk Bonds

People usually are surprised when I tell them that high-yield bonds are more likely to follow stocks than bonds. There is a lot of misunderstanding about high-yield bonds. But that doesn’t stop people from drawing conclusions about how the recent downturn in junk bonds and the failure of Third Avenue Value Focused Credit will affect markets and the economy. Here’s a post with interesting charts and information about high yield bonds.

Here’s something else to consider — this junk bond data only goes back to 1983. In that time interest rates have been in a free-fall. How relevant will the past interest rate cycle really be to the future cycle? It’s still a relatively new asset class, with many new investors to the space. Anyone trying to definitively make a case for risk assets one way or another based on the action of high yield will likely end up being surprised. There’s just not enough historical data to go on, nor is there a past cycle that will provide guidance for how the next cycle will look.

There’s a good chance you’re going to be seeing more and more high yield “experts” pop up in the coming days and weeks if these losses continue. A little perspective is necessary to better understand this segment of the bond market. According to Barclays Capital, there is just shy of $1.3 trillion in the high yield market. That number has more than doubled in the past 10 years or so.