What is high yield debt?

High yield bonds, also called junk bonds, are corporate debt securities rated below investment grade by credit rating agencies. In the S&P/Fitch system, this means a rating of BB+ or lower. In Moody's system, Ba1 or lower. These issuers pay higher interest rates to compensate investors for the greater risk of default compared to investment-grade borrowers.

The high yield market is roughly $1.5 trillion in size and includes a wide range of borrowers, from fallen angels (formerly investment-grade companies that were downgraded) to smaller companies that lack the financial profile for higher ratings to leveraged buyout targets carrying heavy debt loads. The diversity of issuers means that credit analysis at the individual bond level is essential, unlike investment-grade or Treasury markets where broad macro factors dominate returns.

High yield returns are driven by both interest rate movements and credit conditions. Because high yield bonds pay significantly more coupon income than Treasuries, they are less sensitive to interest rate changes (lower duration) but more sensitive to economic conditions and default rates. During recessions, high yield spreads widen dramatically and default rates rise from a normal 1-3% per year to potentially 10% or more, causing significant price declines.

The most widely used high yield benchmarks are the ICE BofA US High Yield Index and the Bloomberg US High Yield Index. The HYG ETF (iShares iBoxx High Yield) and JNK ETF (SPDR Bloomberg High Yield) provide liquid, tradable exposure. Credit default swap (CDS) indices like CDX HY offer a synthetic way to take positions on high yield credit risk.

For portfolio construction, high yield occupies a middle ground between equities and investment-grade bonds. It offers equity-like returns with lower volatility than stocks but higher volatility than investment-grade bonds. High yield tends to perform well in environments of moderate economic growth, stable or declining rates, and improving credit conditions, but can suffer sharp losses when recession risk rises or financial conditions tighten rapidly.