Will yields on high-yield bonds get even lower?

Leslie Shaffer | Writer for
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The yields on high yield bonds already aren't living up to their name, but some analysts believe they could be pushed even lower despite expectations interest rates will rise.

"Historically, high yield tends to behave more like stocks than bonds," said Jonathan Liang, senior portfolio manager for fixed income at AllianceBernstein, which has around $466 billion under management.

"Treasurys will definitely be face considerable headwinds, but some more economically sensitive sectors such as high yield, may see more resilience," he said.

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Many now view U.S. high-yield bonds as overvalued, with fund managers calling it one of the most crowded trades, according to the Bank of America-Merrill Lynch's survey of fund managers for June.

Bonds 'won't explode' with Fed rate hike: Pro
Bonds 'won't explode' with Fed rate hike: Pro

Yields in the segment have plummeted as central banks in developed markets have kept interest rates at effectively zero. The Merrill Lynch Global High-Yield Constrained index is yielding around 5.05 percent, down from its 52-week high of 6.72 percent, while the broader Barclays Capital Aggregate Bond index is yielding around 2.33 percent, down from its 52-week high of 2.68 percent.

But with analysts beginning to game when the U.S. Federal Reserve will begin to raise interest rates, bond yields – which move inversely to yields – are expected to rise across the spectrum.

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Liang noted that during last year's "taper tantrum," when markets convulsed after the Fed first broached its plan to begin tapering its asset purchases, the U.S. 10-year Treasury yield climbed by around 1.5 percentage points to around 3 percent by the end of 2013.

"That's a pretty sharp spike up in yield over a short period of time," he said. "But if you look at the performance of high-yield bonds as an asset class last year, they were up around 7.5 percent on a total return basis."

Read More Are Treasury yields headed for Japanese levels?

Others aren't as convinced that rising interest rates will make high-yield bonds even more expensive.

"High-yield bonds are less sensitive to rate rises than investment-grade bonds. That might shield it from adverse price moves as rates rise," Clifford Lee, head of fixed income at DBS, said in a phone interview last week. But he added, "To say it will go up with rate hikes is a much stronger statement."

Lee doesn't believe the high-yield market is necessarily over-valued, despite the relatively low yields.

Why long-end bonds aren't seeing higher yields
Why long-end bonds aren't seeing higher yields

Managers would only see the segment as over-priced if they were expecting a correction, but investors now expect interest rate increases will only be muted and over the medium term, he said of the Asian bond market. But that doesn't mean bond prices would necessarily rise from here, he said.

"The current market sentiment is not overly euphoric to the point they would buy at any price," Lee said. "New high-yield deals priced at the current values will be well received."

'Risky' no more?

But while it isn't clear whether higher interest rates would push high-yield bonds even lower, there is another factor that might push up prices for the supposedly riskier segment: it might not be terribly risky anymore.

Most of the issuance coming to market over the past couple years has been refinancing related, rather than traditional leveraged buyout or merger and acquisition deals, AllianceBernstein's Liang noted.

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"Refinancing is nice, low risk use of capital, but also it turns out the maturity profile of the market," Liang noted. That means the piper won't need to be paid for a good while yet, with Liang noting that there aren't many maturities for the next two or three years.

"This is being reflected in the low default rate we see in the high-yield market. That low default is probably here to stay for a couple of years," he said.

Read More My bad! Rising rates don't have to mean negative bond returns

Moody's 12-month trailing global speculative-grade default rate came in at just 2.3 percent in May, equivalent to two companies defaulting in the month, down from a 2.8 percent rate at this time last year. Moody's expects the global speculative default rate will fall to 2.1 percent by year-end and then rise to around 2.4 percent a year from now.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1