What are High Yield Bonds?High yield bonds are corporate securities with credit ratings below investment grade. Since non-investment-grade companies usually pay higher interest rates than more creditworthy borrowers, their bonds are called “high yield.” High yield bonds can be used to diversify an investment portfolio because their performance has a low correlation with investment-grade bonds such as Treasuries. Like stocks, high yield bond prices are more sensitive to the economic outlook and corporate earnings than to day-to-day interest rate fluctuations. While high yield bonds share some behavioral characteristics with stocks, their overall returns should be less volatile because their income is normally much higher.
Credit analysis is central to high yield bond investing. It focuses on individual characteristics and fundamentals of issuers as well as the downside risk of default. Portfolios of high yield bonds are diversified by industry group and issue type. Today’s vast high yield market enables portfolio managers to achieve extensive diversification by industry, issuer, as well as by the individual issue within a credit’s capital structure. By actively managing portfolios, PIMCO seeks to lower portfolio volatility while enhancing returns.behavioral characteristics with stocks, their overall returns should be less volatile because their income is normally much higher.
The principal reasons for investing in high yield bonds are diversification and the potential for superior risk-adjusted returns over a full market cycle. High yield bonds have typically had a low correlation with most other fixed income sectors, enhancing the risk return profile of a broader core fixed income portfolio over the long term. Additionally, high yield bonds have been used as a substitute for equities, given a similar return profile to the asset class and generally lower volatility.
1) Bottom-up credit research incorporating top-down economic framework
2) Total return approach, not just yield focused
3) Focus on credits with best risk/return profile
4) Seek to limit risk through issuer and industry diversification
Our credit research framework focuses on business and financial risk at the issuer level, as well as security specific risk with the structure of the issue. With respect to business risk, we evaluate the overall industry dynamics, the company’s competitive position within the industry, the quality of the business plan and the quality of management and their ability to execute on the business plan. In terms of financial risk, we evaluate a variety of financial ratios measuring leverage, cash flow, interest coverage and liquidity.
Default and spread widening risk are the dominant potential risks in purchasing corporate debt securities. Our focus on higher quality corporates, combined with our comprehensive evaluation of credits, both at purchase and on an ongoing basis, reduces the risk of downgrade or default.
There are four common criteria that each analyst will focus on: 1) business model 2) cash flow 3) balance sheet, and 4) security structure. The specific metrics and financial ratios will vary based on the industry and as a result the format of reporting the analysis will also vary. In addition, emphasis on the four factors listed above will also depend on the industry, however the general criteria applied to the analysis is consistent across our Global Credit Research team.
Macroeconomic FocusPIMCO’s robust, top-down macroeconomic analysis of the world’s major economies sets the tone for the structure of our credit portfolios. The assessment of the direction of global economic growth and interest rates provides important insight in choosing the optimal portfolio structure and sector allocation within this strategy.
In addition to PIMCO’s disciplined approach to fundamental credit research, extensive analytical tools are used to measure and monitor the risk characteristics of the portfolio. PIMCO has invested considerable resources in developing proprietary models and analytical tools that enable a robust approach to risk management. These tools are important in managing credit strategies as their flexibility facilitates analysis at the regional, sector and security level. These models include our Bonds Under Management report, which provides an extensive summary of portfolio holdings and portfolio level risk characteristics. Additionally, the PIMCO Position Blotter system provides risk and portfolio structure information, allowing for the aggregation of detailed security-level information into a variety of risk matrices including sector and issuer exposure by quality and duration bucket.
Extensive use of analytical tools allows us to maximize the value of our investment professionals and provides a dispassionate check on our investment decisions. These systems also augment our understanding of the strategies that have consistently added value to our clients’ portfolios.
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All material contained on the Exchange-Traded Funds section of this website is purely for informational purposes only and is not intended as investment advice. Investors should seek financial advice before making any investment decisions.
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