Historic Changes in the High Yield Bond Market

In a history that now stretches about four decades, the high yield (HY) market has experienced growth in issuance and out-standings that is remarkable both for its level (about 13% per annum, with HY bonds now accounting for about 25% of the total corporate bond market) and its cyclicality and sensitivity to the broad economy. The HY market has also experienced a notable shift away from B-rated bonds and toward both lower-risk Ba-rated bonds and, to a lesser extent, more risky Caa-rated bonds. Consistent with this development, studies of the performance of HY bonds show Ba-rated bonds experiencing not only lower risk, but also higher returns than Caa-rated bonds, which have produced surprisingly low average returns along with exceptionally high volatility. At the same time, studies of the correlation of HY bond returns with returns on other major asset classes report that all classes of HY bonds (but particularly the riskier B- and Caa-rated bonds) have consistently stronger relationships with common stocks (especially small-cap stocks) than with Treasuries and investment-grade bonds. Copyright Copyright (c) 2009 Morgan Stanley.