High Yield Vs. Investment Grade
High yield and investment grade represent opposite ends of the spectrum for bond ratings. Different degrees of risk and reward are associated with high-yield and investment-grade bonds. Investors who are willing to accept a larger degree of risk in their portfolios are better suited for high-yield bonds, while investors who are willing to earn more moderate returns in exchange for safety should choose investment-grade securities.
High-yield bonds are issued by corporations. These debt securities are assigned a grade by industry rating agencies that falls below investment-grade status. This rating is a sign to investors that the risk associated with high yield is great. In exchange for that risk, high-yield bonds pay higher rates of return. Investment-grade bonds are rated to reflect the best quality and lowest credit risk to investors. These securities may be issued by government agencies or corporations. Investment-grade issuers are less likely to default than high-yield issuers.
Investors often choose to invest in fixed income as an alternative to the stock market. One of the benefits of high-yield bond investing is that investors gain exposure to an asset class that does not exhibit the same price volatility as the equity markets but can reap similar returns. Investment-grade bonds, on the other hand, offer investors an option that is non-correlated to stocks, in that each asset class is influenced by a separate set of factors.
Investors with an investment portfolio that is too heavily weighted with high-yield bonds run the risk of severe loss. On the other hand, by avoiding risk altogether, an investor might not achieve the returns that are needed to reach financial objectives. Given the risk of default that high-yield bond issuers present, a suitable exposure to risky securities such as high-yield debt is one-fifth of an investment portfolio, according to an article on the Charles Schwab website.
The difference in returns between high-yield and investment-grade bonds can be measured. Under normal economic conditions, high-yield bonds generate returns that are between 300 and 400 basis points higher than U.S. Treasuries with similar contract durations. When the economy is in recession, the difference in returns escalates, according to bond investor PIMCO.
Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.