Another Warning on High-Yield Bonds

My recommended portfolios have owned high-yield bonds for a while now, and they’ve been good performers. But there’s good reason to be careful. I have sell signals in place and would not be surprised to see them triggered at any time.

Investors have been pouring money into high-yield bond funds, and companies are taking advantage of that by issuing all the bonds they can. The quality on the market is declining, and the prices for high yield bonds are high. The yields on the bonds have declined to the point that some people half-seriously question whether they really can be called high-yield bonds any longer. The Washington Post joined the chorus with a report that bond fund managers are having trouble investing all the money flowing in. T. Rowe Price and Vanguard closed their high-yield bond funds to new investors. Other managers are working hard to invest the new money without taking too much risk. Investors need to be careful. Invest only with the most conservative managers, and be prepared to sell at signs that the inevitable exodus of hot money and uninformed investors are moving elsewhere.

Gitlin and others say recent trends remind them of the easy-lending era before the financial crisis, when Wall Street and bond traders treated caution as a sign of weakness.

“When you start seeing things like you saw in ‘06 and ‘07, you should be concerned,” Gitlin says.

Over recent months, more than a third of the money raised in the market has gone to corporate borrowers that credit rating agencies consider likely candidates for bankruptcy, those with the lowest of the low credit scores, according to S&P.