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In today’s investment landscape, where inflation lingers and the global economy searches for stability, investors are asking a fundamental question: where can I find income without taking on excessive risk? One answer, often overlooked, are High Yield (HY) bonds, an asset class that sits at the intersection of credit quality and opportunity.
For decades, HY bonds have been dismissed as speculative or too volatile. But these labels often overlook the strategic role they can play in diversified portfolios, especially when approached with care and insight. This blog aims to demystify HY bonds and explain why they deserve fresh consideration today.
Fixed Income today: Higher yields, higher stakes
Global bond markets have undergone a regime shift. After years of ultra-low rates, the fight against inflation has led central banks to hike aggressively. While rate increases have hurt longer-duration assets, they’ve also put income back in the fixed income universe.
Today, fixed income offers income again. But not all sectors are created equal. Government bonds provide safety, but limited upside. Investment-grade corporates yield more but may come with longer duration and interest rate risk. HY bonds, however, offer a sweet spot: elevated income, moderate duration, and diversification potential.
What are HY bonds?
HY bonds are corporate debt instruments rated below Investment Grade (IG), BB+ or lower by S&P, or Ba1 or lower by Moody’s. Issuers span sectors from energy to healthcare and include both emerging firms and established companies with higher probability of default (relative to IG companies). Many HY issuers are improving their financials, and over half of the market is rated BB or higher—the upper tier of non-IG.
Key characteristics:
- Yields are typically well above IG corporates or Government Treasuries
- Shorter duration (~4 years average) helps buffer against interest rate volatility
- Higher return dispersion opens the door for active managers to add value to portfolios
- Can be issued in both U.S Dollar and global currencies
Why invest in HY – and why now?
Enhanced return potential in a lower-growth world - As equity markets face valuation pressures and bonds reset to higher yields, HY bonds stand out. The yield-to-worst¹ on HY indices remains elevated—meaning investors are paid to wait, and the breakeven cushion is strong even if spreads widen modestly. Historically, HY bond returns have been closely correlated with equity returns, but with less volatility.
A strategic diversifier - HY bonds are less correlated to interest rate movements than IG credit, due to their shorter duration. Their behaviour is more aligned with economic growth and corporate health—making them a useful hedge in environments where growth is positive but uneven. They also serve as a diversifier to equities. While more correlated to stocks than Government Treasuries and IG bonds, HY bonds often hold up better in equity drawdowns.
The current environment:
- Yields are historically high: mid-2025 HY yields are in the 7–9% range
- Default rates remain manageable, with improving credit quality and balance sheets
- Technical support from institutional investors seeking income and pension rebalancing
HY myths that still linger
Myth: HY = Junk = Avoid
Reality: Over 50% of the HY market is rated BB, just below IG. Many strong businesses get penalized for high leverage
or cyclical revenue.
Myth: They only do well in boom times
Reality: HY has performed well in moderate growth environments. The income cushion helps smooth returns.
Myth: All HY is the same
Reality: This is a highly heterogeneous market, with dispersion in credit quality, sector exposure, and interest rate sensitivity.
Active management matters.
Risks: What investors should understand
No investment is risk-free, and HY bonds come with real trade-offs:
- Credit/default risk: The key risk is that the issuer will fail to repay. In the HY space, defaults are not unusual and the restructuring process that follows may provide an opportunity for higher returns
- Liquidity risk: In stressed markets, bid-ask spreads can widen which can make HY relatively illiquid
- Refinancing risk: As maturities near, some HY issuers may struggle to refinance at higher rates
- Macroeconomic sensitivity: HY bonds can underperform in deep recessions or systemic shocks
Risk mitigation starts with broad diversification, sector awareness, and active credit research.
HY with a fresh lens
The HY bond market has matured. With stronger fundamentals, reduced default risk, and more sophisticated active strategies, HY is not just a speculative investment—it’s a core part of the modern fixed income toolkit. For investors seeking resilient income, diversification, and upside potential, HY deserves serious attention—particularly in this new regime of normalized rates and credit-driven returns.
¹ The lowest potential yield that can be received on a bond, assuming the issuer uses any provisions that would negatively impact the bond's yield, such as calling the bond or using a sinking fund.
The information contained herein has been provided by TD Asset Management Inc. and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.
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