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High yield bonds for capital growth

By: BILL BLEVINS

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Bill Blevins is Managing Director of Blevins Franks. He has specialised in expatriate investment and tax planning for over 35 years. He has written books and gives lectures on this subject in Southern Europe and the UK.

NOW THAT bank interest rates in the US, the UK and very probably the EU are starting to fall, it’s a good time to review your financial planning and consider moving some of your cash into high yield bonds.

They usually provide higher income than deposit accounts, at a lower risk level than equities, and they often perform better when interest rates are low. Bond funds are also useful to provide stability in an investment portfolio.

High yield bonds are a generally popular form of investment for retirees. Many are cautious about their capital and don’t want to put their money to undue risk.

They often prefer investments that have the potential for steady income and capital appreciation.

Bonds are an asset class known as fixed interest securities. They are usually issued by governments or companies who want to raise money.

In buying a bond you are making a loan to a government or corporation in return for a regular income called a yield or coupon.

The issuer will reimburse you the face value of the bond when it matures, usually on a set date in the future.

The income provided does not necessarily depend on the price of the bond.

Bonds issued by developed governments and established corporations are considered to be low risk.

They are unlikely to default on the yield and for this reason generally pay a lower but reliable return.

Where bonds are issued by developing corporations, the risk to your money is higher and therefore they promise to pay a higher yield for your investment.

Small and middle sized companies are more likely to issue high yield bonds.

They could need the capital for expansion or simply to see them through the years until they become established.

Companies that have been established but suffered a setback could also issue high yield bonds to see them through the recovery process.

Companies in the first group are referred to as “rising stars” by the credit rating companies and those in the second group are called “fallen angels”.

As well as developing companies, high yield bonds are also issued by developing or emerging economies.

Europe, especially the emerging eastern European countries, South America, and Asia namely China, India, Korea, Thailand, Singapore, Brazil and even Russia are all promising rising stars and offer the opportunity for high yields and capital growth over the mid to long term.

Credit rating companies, such as Standard & Poor’s and Moody’s, rate bonds according to the credit risk of the issuing corporation or entity.

Capital growth

Those bonds that hold an “investment grade” status have a medium to high level of credit worthiness and will be issued by established and reliable companies, governments or organisations.

Those bonds rated as “non investment grade” will have a lower credit worthiness and are often issued by developing governments, corporations or organisations, where there is a higher risk of default.

Non investment grade bonds are called high-yield or high income bonds.

In the past, they were also called “speculative” or “junk bonds”, which referred to bonds which were issued to finance speculative takeovers and mergers.

As the years went by, these bonds gained esteem since they are issued mainly by growing companies and today are a much favoured way of investing.

Their potential for returning high yields and long-term capital growth form an important component of a modern day diversified portfolio for most investors.

High yield bonds have yet another advantage.

The value of the bond will increase if the issuing company becomes more successful and is upgraded, thus providing more capital appreciation.

In some cases, a bond will convert to equity.

If a listed company does go into bankruptcy, bond holders have priority over shareholders on the creditors’ list.

The best way to invest in high yield bonds is through a bond fund.

A bond fund is designed to mitigate risk and maximise the returns.

The bonds in a bond fund should represent a widespread variety of issuers from different industries, sectors, geographical zones, credit ratings and currencies.

Bond funds are managed by highly skilled professionals who constantly monitor the markets and buy and sell bonds in the fund to achieve the best possible returns.

Another advantage of a bond fund is that, according to the fund and your circumstances, you can elect to receive the interest payments quarterly, half-yearly or annually.

If you are not using the interest as income you can reinvest the yield in the fund, thereby increasing its earning power.

If the bond fund is placed in an appropriate “tax wrapper”, by not taking the interest as income you can make tax savings since only withdrawals are subject to tax, often beneficially.

Tax free income and gains can accumulate in the fund increasing its value further.

Even though high yields bond funds are a very attractive asset class they would usually be held in an overall well diversified portfolio, normally including some equity and property funds as well as cash.

The percentage of each asset class that you hold in your portfolio will depend on your aims and objectives and an independent financial adviser will recommend the right portfolio for you.

Remember that the value of shares in a bond fund can go down as well as up.