High-Yield Corporate Bonds: A Comprehensive Guide

Investors interested in potentially higher returns may prefer high-yield corporate bonds (also called junk bonds). Still, they should realise these options can be more risky than regular investment-grade corporate bonds. Here, we will discuss what high-yield bonds involve, the reasons companies may offer them and whether you should add them to your investment portfolio in India.

Definition of High-Yield Bonds

High-yield bonds are corporate bonds that pay a higher market interest rate than investment-grade bonds. They have a lower credit rating than investment-grade bonds. They are rated below 'BBB' by S&P and Fitch, or below ‘Baa3 by Moody's. 

The junk bond label is an undesirable and somewhat derogatory name. One should remember that while high-yield bonds are not considered investment-grade bonds, they can serve a legitimate role in the context of a diversified portfolio. They can ensure a higher income than investment-grade bonds.

Why Do Companies Issue High-Yield Bonds?

There are many reasons why companies would issue high-yield corporate bonds, especially companies that cannot secure investment-grade ratings, because they are rated below investment grade because the companies:

• Have a weak credit profile or high debt
• Have a little operational history
• Is part of an industry that has a high risk associated with it
• Are undergoing a solvent restructuring or an expansion

These companies are offering investors higher yields in exchange for undertaking more credit risk in order to receive better returns.

Features of High-Yield Corporate Bonds

High-yield bonds have several distinct characteristics:

• Higher Coupon Rates: To compensate for greater risk, they offer higher interest payments.
• Lower Credit Ratings: Assigned by agencies like CRISIL, ICRA, CARE in India, or Moody’s and S&P internationally.
• Shorter Maturity Periods: Many high-yield bonds mature within 3–7 years.
• Callable Feature: Issuers may redeem the bond before maturity to refinance at lower interest rates.
• Higher Volatility: Sensitive to economic cycles, interest rates, and company-specific news.

High-Yield Bonds vs Investment-Grade Bonds (Comparison Table)

Here is a brief comparison of high-yield bonds and investment-grade bonds based on varying parameters. 

Benefits of High-Yield Corporate Bonds

Here are some benefits of high-yield corporate bonds worth noting: 

1. Higher Returns

The interest rates on these bonds are often better than on government or investment-grade corporate bonds, which people find helpful in times when interest rates are low.

2. Portfolio Diversification

They are used to give balance to portfolios because they differ in risk and returns.

3. Income Generation

Retirees among income investors might find that high-yield bonds offer a steady source of cash.

4. Capital Appreciation Potential

If a company’s financial situation gets better, the bond’s credit rating can go up, which often brings up the bond’s price in the market.

Risks of High-Yield Bonds

Here are some of the risks of high-yield bonds you should be aware of: 

1. Credit Risk

The most serious problem is that the borrower may fail to pay back either interest or principal on time.

2. Interest Rate Risk

If interest rates increase, high-yield bonds may lose part of their value, especially when they mature in the distant future.

3. Liquidity Risk

Although it is hard to sell some bonds before their terms are complete, since secondary markets are not as accessible.

4. Market Risk

Economic downturns, poor industry performance, or geopolitical tensions can hurt bond prices.

5. Reinvestment Risk

Callable bonds can be redeemed early, and investors may have to reinvest at lower interest rates.

How to Evaluate High-Yield Bonds Before Investing

Evaluation of high-yield bonds necessitates a careful examination of several factors. These include: 

• Credit Rating: Always check ratings from reputable agencies like CRISIL, ICRA, or CARE.
• Issuer Financials: Review the company’s balance sheet, debt-equity ratio, and cash flow.
• Interest Coverage Ratio: A higher ratio indicates better debt-servicing capability.
• Industry Outlook: Companies in declining or volatile industries pose higher risks.
• Bond Structure: Check if the bond is secured or unsecured, callable or non-callable.
• Yield to Maturity (YTM): Understand the actual return if held till maturity.

Due diligence is critical, and investors should not be swayed solely by high coupon rates.

How to Invest in High-Yield Bonds in India

Here’s how you can invest in them: 

1. Through Brokers and DPs

Many SEBI-registered brokers and Depository Participants (DPs) offer high-yield bonds on their platforms. You can buy these like any other listed security.

2. Bond Platforms

Specialised online bond platforms aggregate offerings and allow you to invest with relatively low minimum amounts.

3. Debt Mutual Funds

Some mutual funds invest in a mix of low-rated/high-yield bonds. Look for credit risk or high-yield bond funds.

4. Private Placements

High-net-worth individuals (HNIs) often get access to privately placed high-yield debt via financial advisors.

Always ensure that the bond is listed on exchanges like NSE or BSE for better liquidity and regulatory transparency.

Tax Implications

1. Interest Income

• Taxed as per your income tax slab under “Income from Other Sources.”
• TDS may apply, especially for NRIs.

2. Capital Gains

• If sold before maturity:
• Short-Term Capital Gains (STCG): Taxed as per income slab.
• Long-Term Capital Gains (LTCG): Taxed at 20% with indexation if held for more than 36 months.

3. Tax-Free Bonds

Some government bonds are tax-free but are usually investment-grade and not “high-yield” in the typical sense.

Final Thoughts

Since high-yield bonds can bring higher income, investors need to be aware of the risks involved. You must check the features, ranking criteria and tax consequences before you invest your money.

It is a good idea for retail and NRI investors to choose reliable platforms, seek advice from financial experts and select bonds that fit their financial objectives and specific risk tolerance levels.