Junk bonds have benefited both investors and issuers over the past few years, providing borrowers with some of the lowest interest rates ever, while providing yield-hungry investors with better returns than they could receive by investing in investment-grade debt. Junk bonds produce higher yields because of the increased risk of default by the issuer. "But investors run the risk of having the tide turn against them should interest rates start rising. Some analysts have begun suggesting that day could come soon" ("Junk Bonds Feed a Hungry Market," by Matt Wirz, Wall Street Journal).
So far this quarter, 130 companies have issued $75 billion in junk bonds. That is up 12 percent from the same quarter last year and is the most since Thomson Reuters began compiling data in 1980, according to the article. Junk bond mutual funds, along with their ETF cousins, reportedly have seen record inflows of $18.6 billion through March 26.
Supply of junk bonds has picked up in anticipation of higher interest rates. Demand has soared as investors have become less risk averse. Despite the belief that the Federal Reserve will keep interest rates low, experts are warning that they may soon begin to rise. As interest rates rise, bond prices fall, which would be a problem for investors in junk bond mutual funds.
Higher interest rates may also cause the economy to falter, leading to more defaults. "This is the talk of the market," Matt Conti, a manager of high-yield investments at Fidelity Investments, was quoted as saying, adding: "My general view is it's time to be defensive."
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