Stay defensive on US high yield bonds

THE rally in risk-assets this year has been nothing short of outstanding. While equity markets around the world enjoyed a strong first quarter, and continue to do so, I have also noticed that the rebound in the non-investment grade credit markets has been rather strong. Due to their decent performance, investors may be tempted to chase the rally out of the fear of missing out. However, doing so at this point in time may not be a good idea.

Unlike equities, which are reliant on earnings growth and valuation multiple expansion, non-investment grade bonds are simply riskier bonds with higher credit risks but with a commensurately higher yield that investors can collect compared with investment grade bonds. This means that bondholders do not participate in the future growth prospects of a company unlike owners of equity securities.

These non-investment grade bonds, also known as high yield bonds, have higher credit risks because they are typically issued by companies perceived to be riskier than other companies that have tapped the bond market (hence their name "junk"). Yields tend to be higher than other kinds of bonds to reflect these known risks.