Original Issue High-Yield Bonds

Abstract

In the past full market cycle, original issue high-yield bonds delivered no material total return premium over default risk-free Treasuries. This represents a bona fide market inefficiency that proved exploitable by one group engaged in actual market transactions; the corporate sellers of new issues escaped paying a default risk premium. Among the five complementary rather than mutually exclusive factors identified here that may explain this anomaly are: unawareness of the underperformance of the OI segment; a focus on security selection; a lottery ticket effect; and the mirage of remedy based on yield. The discussion gets to the heart of the premise on which the high-yield investment concept was marketed at the dawn of its modern era in the late 1970s.

TOPICS: Risk management, fixed-income portfolio management, portfolio construction