GO
Loading...

Investment grade the new junk? The trouble with investing

Central banks have had a massive distorting effect on several asset classes, two analysts have told CNBC, with investment-grade fixed-income assets now yielding more than riskier "junk" debt.

"We've had buyers from our investment grade fund coming out of high yield because we're actually yielding more," Bryn Jones, head of fixed income at Rathbones told CNBC Wednesday.

Government bond yields have been suppressed in recent years thanks to the U.S. Federal Reserve's massive bond-buying program which has boosted the price of Treasurys and, because of the inverse relation between the two, pushed yields lower.

(Read More: Dream run in US stocks set to end: HSBC)

Peter Gridley | Taxi | Getty Images

In turn, this has skewed asset prices, with investors searching for better returns by loading up on riskier debt. This speculative grade -- or junk debt -- refers to bonds that carry a rating of 'BB' or lower from Standard & Poor's or 'Ba' or below from Moody's. They have a higher risk of default compared to investment-grade debt but give a better return for investors as yields are higher.

The issuance of European junk bonds has surged a "phenomenal" 98 percent in the last year, according to a December report by S&P Capital IQ. These junk bonds may have yielded 10 percent in a normal scenario but have fallen to rates of 5 to 7 percent with loose monetary conditions.

(Read More: Junk bond issuance in Europe reaches record in 2013)

But Jones indicated that investment grade bonds tend to be longer duration assets than the high-risk investments. Because of the longer term, effects of inflation on its value would be greater - making it less attractive and thus giving it a higher yield.

"High yield obviously being at the front end of the (bond curve), and pricing off of much lower government bond yields, you tend to find in some indices that high yield actually yields less than investment grade," he said.

However, Michael Browne, an equity fund manager at Martin Currie said that the earnings' yield on equities was greater than the return on these investment grade bonds.

(Read More: Take cover! Bond market 'hell' could be on the way)

"That is a misnomer, that shouldn't be happening," he told CNBC Wednesday. "I can find many companies on the (Euro Stoxx 600) where the yield in the equity is higher than the debt."

This unusual skewing of asset markets has led to more and more leverage, according to Jones. He added that buybacks - where companies buy up their own stocks to improve the price - is being funded by the company issuing more debt instead of cash.

"This is one of the things I've been worried about," he said.

By CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81

Symbol
Price
 
Change
%Change
STOXX600
---