High-yield debt investment: How to consistently achieve substantial returns?

Against the backdrop of a general decline in global bond yields in 2019, the domestic high-yield debt market stood out, with many domestic and foreign securities firms, private equity funds, and even public offering funds expressing optimism towards high-yield debt investment. The high-yield debt market is gradually developing towards higher trading activity, a wider range of participating institutions, and improved liquidity.

According to Guotai Junan Securities' statistics, as of September 2019, the outstanding amount of credit bonds with yields exceeding 6% in the credit bond market reached 3.64 trillion yuan, accounting for 16.3% of the total 22.3 trillion yuan of credit bonds.

As one of the active management strategies for bonds, the core idea of the high-yield debt strategy is to obtain excess returns by buying high-yield credit bonds while bearing some losses from bond defaults. The default rate and recovery rate are two important factors affecting the returns of high-yield debt strategies.

So how can one continue to obtain considerable returns from high-yield debt investments?

Essentially, high-yield debt investment is like other bond investments; to continuously obtain considerable returns, one must consider timing and selection. Timing refers to choosing to invest during periods favorable to high-yield debt investments. Selection refers to choosing bonds with high yields but relatively lower risks.

Specifically for domestic high-yield debt investment, given the frequent credit risks in the past two years, selection will be more important to some extent. Selection first prevents stepping on landmines (defaults), then considers the cost-effectiveness after taking recovery rate and liquidity into account.

Referring to the credit bond default rate, it is necessary to reasonably allocate assets such as local government financing vehicles (LGFVs) and private enterprises. The default rate of publicly issued LGFV bonds has been zero to date, and the default risk is relatively low, implying certain "high-yield, low-risk" value mining opportunities; however, for this very reason, the overall yield of LGFV bonds in the high-yield debt market is also relatively low. The balance of defaulted bonds of private enterprise bonds accounts for about 10% of the total maturity, accounting for 11% of the total bond financing scale of the market, contributing more than 80% of bond defaults; however, within the high-yield market, private enterprises have greater volatility, and high-quality leading private enterprise bonds have greater opportunities to obtain excess returns.

Warren Buffett, the investment guru, also invests in high-yield bonds. His investment strategy is: If you are willing to buy the company's stock, then high-yield bonds can certainly be bought too. Equity and debt have the same origin; ultimately, both equity and debt benefit from the long-term growth of the enterprise.

In general, in-depth identification and tracking of credit risks in high-yield debt are the basis for continuously obtaining considerable returns.

Now let's talk about the timing of entry.

In 2018, credit risks in the bond market frequently occurred, with a large number of defaulted and near-defaulted bonds appearing. Under the depressed market sentiment, the price of high-yield bonds was reasonable, representing a very good buying opportunity.

In 2019, from January to May, with the significant improvement in the effectiveness of the high-yield debt market, yields returned to their average, and good buying opportunities gradually decreased. However, since June, under the impact of the Baoshang Bank incident, the situation of liquidity stratification and credit expansion stratification has emerged, once again providing a good buying opportunity for the high-yield debt market.

High-yield bonds enjoy high returns and the asset attributes of passive investment. The market is relatively independent, with a low correlation coefficient with other major asset classes, and volatility lower than stocks, making them an indispensable part of a diversified investment portfolio.

However, there is an iron law in the financial market: all returns come from risk-free returns plus risk premiums. The returns of high-yield bond portfolios rely more on the risk control capabilities and active management capabilities of managers. If ordinary investors want to participate, they should mostly rely on excellent managers to operate.

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