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Why the Return of Junk Bonds Poses Risk for Individual Investors

February 9, 2016 Blog

Junk bonds are back. A type of high-yield security that involves loaning money to a non-investment-grade company, “junk bonds” got their name because they are also extremely high-risk for both institutional and individual investors. While some bonds are junk from the beginning, others can become junk bonds when a company performs poorly, resulting in a downgrade of its credit rating and investment status.

For the better part of the last three decades, we haven’t seen much in the market in the way of junk. However, financial experts have attributed at least a portion of the recent surge in market volatility to the return of the junk bond. This raises concerns for individual investors on a few different fronts.

The Allure of High-Yield Junk Bonds

First, for many individual investors, the prospects of a “high-yield” bond can be very alluring. After all, who doesn’t want high yields from their investments? Plus, bonds are supposed to be one of the safest forms of investments, right?

With bank interest rates at record lows as a result of the Great Recession, many investors have shifted more of their assets into corporate bonds. While these bonds promise higher returns, they also carry a greater risk that the company will default – leaving the investor with nothing.

When you get into junk bonds, this risk is even greater. Junk bonds pay higher interest rates precisely because they carry a higher level of risk. While some investors may be willing to take this risk, unfortunately, many jump (or are pushed) into junk bonds without understanding the implications.

Downgrades Convert Existing Bonds to Junk

Another – and perhaps more startling – risk for investors is that even relatively-safe corporate bonds can turn into junk bonds when a company struggles to turn a profit. For example, Moody’s (one of the Big Three credit rating agencies) recently warned that bonds issued by some of the world’s largest energy companies are at risk for junk-level downgrades.

High-Yield Bond Funds Going Under

Finally, even investors who choose to invest in bond funds rather than picking and choosing individual bonds are now facing risks due to the return of sub-investment grade corporate loans. In some cases, high-yield bond funds target junk bonds specifically with the hope of achieving significant returns. In others, bond funds run into the same issue as individual investors with downgrades leading to greater risk.

If fund managers fail to take necessary action in order to prevent investment losses, these funds can spell disaster for unsuspecting investors. Take, for example, the more than $2 billion in losses at Third Avenue Management which occurred in little over a year. Zamansky LLC is currently suing Third Avenue Management behalf of its investors, and is actively pursuing other high-yield bond fund failures as well.

Have You Suffered Junk Bond Losses? Speak with a Lawyer at Zamansky LLC

If you have lost money in a junk bond or high-yield bond fund, the junk bond lawyers at Zamansky LLC may be able to help you recover your losses. For a free, confidential consultation, please call (212) 742-1414 or contact us online today.