Equity risk in a bond wrapper
High-yield bonds are rated below BBB-, meaning the agencies consider default a material possibility rather than a remote one. Issuers are typically leveraged buyouts, cyclical businesses, or companies that have fallen from investment grade — "fallen angels".
The defining characteristic is that returns correlate more with equities than with government bonds. In a recession, high yield falls with the stock market while gilts rise. That makes it a poor diversifier precisely when diversification is the thing you needed.
Yield is not return
A fund quoting 8% is not offering 8%. From that, subtract expected defaults — long-run averages are roughly 3–4% a year across a cycle, far higher in a bad one — and then subtract the loss given default, since recoveries on unsecured high-yield paper have historically been well under 50%.
The realised return across a full cycle has historically been a few percentage points over government bonds. Respectable, but nothing like the headline yield, and earned with equity-like drawdowns along the way.
Covenants
The protections in the documentation matter more here than anywhere else: limits on further borrowing, restrictions on moving assets out of the borrowing group, requirements to maintain financial ratios. A long bull market in credit erodes these — "covenant-lite" issuance became standard in the 2010s — and the consequence appears years later in lower recoveries when things go wrong.
How you would actually trade it
Retail access is through funds and ETFs. Understand that a high-yield ETF promises daily liquidity on an asset class that does not have it; in stressed markets these have traded at meaningful discounts to NAV, which is the arbitrage mechanism telling you the underlying cannot be sold at marks.
Compare funds on credit quality distribution, sector concentration (energy has historically dominated US high yield) and effective duration.
What goes wrong
- Default clustering. Defaults do not arrive smoothly; they arrive all at once in recessions.
- Liquidity evaporation. March 2020 saw high-yield trading effectively seize until central banks intervened.
- Correlation failure. Falls with equities, so it does not protect a portfolio.
- Refinancing walls. Many issuers rely on being able to refinance at maturity. When credit markets close, otherwise solvent companies default.
This entry describes how a market works. It is not a recommendation, a price forecast, or advice about whether this belongs anywhere near your money. How entries are written.