Is there a buying opportunity in high yield bonds? If the worries about the global economy subside, so will volatility and junk bond yields. Of the 199 high-yield bond funds tracked by Lipper, 179 of them are actively managed, and fund managers earn their stripes by finding oversold opportunities.
The credit performance of the sector continues to be good. The trailing 12 month default rate for global speculative bonds was just 2.4 percent at the end of July versus a historical average of 4.5 percent since 1983. Investors who took a similar risk in 2011, were handsomely rewarded. High yield spreads ballooned out to 9 percent in October 2011 on fears about the Eurozone and the credit rating downgrade of the U.S. government, and over the next three years, they narrowed by nearly 6 percent.
This time around, however, the trends on fundamentals and credit performance are working against the market, said Lonski. Moody's is expecting the default rate to rise from here—predominantly due to distressed energy and commodity-related issuers. The general increase in market volatility will also hurt every other non-investment grade company.
"The argument for high-yield bonds looks less compelling today than it was in 2011 when default rates were expected to decline," said Lonski. "The risk/reward doesn't seem as attractive now."
Investors may still be hungry for yield, but they probably shouldn't going looking for it in the junk bond market. "Fundamentals and cash-flow liquidity will take center stage now," Khoda said. "The reach for yield will unwind from here."