Choose your risk

FOR income investors, the level of bond yields is starting to look exciting again after what has been a long lull. Compared with a world of historically low (in many cases zero) interest rates for most of the past decade, yields on many bond asset classes are now approaching multi-year highs as the Fed lifts US dollar policy rates. With yield premiums on several riskier bond asset classes also rising this year, it may once again be interesting to start scouring the fixed income world to look for attractive opportunities.

Investors, of course, should be aware that higher yields do come with their own risks. Wider yield premiums on riskier bonds are often reflective of higher default risks, a factor that has been a challenge in several emerging markets in recent months, for example. Rising interest rates have also meant that the cost of funding for companies and governments has risen alongside.

Financial markets rarely offer a free lunch, but an understanding of the risks involved would enable investors to be better prepared to assess which risks are worth taking in today’s environment, and which ones are not. In general, bond investors can take on 3 major types of risks to generate a yield: