While fixed-income assets are subject to rate risks, junk bond exchange traded fund investors also have to monitor credit risks, but now default rates on speculative grade debt have dropped to a six-year low.
According to Moody’s Investor Service, default rate among junk-bond U.S. companies fell to 1.7% at the end of the first quarter, the lowest since February 2008, from 2.2% in the fourth quarter of 2013, reports Michael Aneiro for Barron’s.
The current default rate is well below the historical default rate for high-yield bonds, which averaged 4.5% since 1993, according to Moody’s data. Moody’s, though, warns that default rates could rise to 2.4% by the end of the year and 2.7% in 2015.
The capital markets “continue to be open for low-rated companies, supporting a low default rate,” Moody’s said.
As a result of the Fed’s record low rate policies, most junk-rated companies have been able to refinance old debt, extend maturities and lower borrowing costs.
Nevertheless, speculative grade, junk bonds are one of the riskier assets in the fixed-income space.
“Investors should bear in mind that high-yield bonds are one of the most volatile sectors of the fixed-income market,” according to Morningstar analyst John Gabriel. “In many cases, issuers are classified as high-yield due to relatively high levels of financial leverage. This means that the risk of default is elevated, as (even for high-quality businesses) financial leverage decreases a firm’s margin of safety.”