Are high yield bond funds a good investment?

High yield bond funds often catch the eye of income investors, particularly at times when savings rates or yields from “safer bonds” do not meet their income requirements. We think high yield bonds can play a useful role in a diversified portfolio, but they do come with risks. If you’re wondering “what are high yield funds?”, and want to know more about how they behave, and where they fit alongside other investments then this article is for you.

What are high yield bonds?

High yield bonds are a type of fixed income investment. In simple terms, they are loans made by investors to companies – known as corporate bonds. When a company issues a bond, it borrows money and agrees to pay interest (called a coupon) for a set period and repay the money borrowed at the end of the bond’s life.

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What makes a high yield bond different is the company’s credit rating. Bonds rated BBB or above are known as investment grade bonds and are considered lower risk. Bonds rated BB+ or below fall into the high yield category. These lower ratings reflect a greater chance that the issuer could struggle to repay its debt – and the potential loss of income or capital to the investor.

In the world of investing, greater risk typically means greater potential reward. Because of this, the extra risk associated with high yield bonds usually means they offer higher income than safer bonds. This could be because the company is highly indebted, operates in a more unpredictable or cyclical industry, or is smaller in scale and less established.

What role do high yield bond funds play in a diversified portfolio?

Rather than buying individual bonds, which can be expensive and require large minimum investment amounts, investors can access this part of the market through high yield bond funds or high yield debt funds specialising in niche areas. These funds hold a wide range of bonds, helping to spread risk through diversification.

High yield bond’s main role is income generation. They typically sit between individual company shares and less risky bonds, offering higher income than government bonds or investment grade debt, but with less volatility than shares. They can therefore complement lower‑risk holdings and add an additional, higher income stream.

High yield funds in the UK can also be used alongside share-based funds to diversify returns, and in terms of total returns cushioning a bit of any downside in shares markets through the regular high income they provide.

How risky are high yield bond funds?

A higher yield is attractive, but it often signals higher risk. The biggest danger is default risk – the chance that a company cannot meet its interest payments or repay its debt. If a company runs into serious trouble, bond prices can fall sharply and, in some cases, investors may suffer non- payment of income or capital losses.

That said, defaults don’t usually mean investors lose everything. Bonds often have some value in restructuring or liquidation, although recoveries vary widely.

High yield bonds also tend to have shorter maturities (often around 7–10 years), as investors are less willing to lend to riskier companies for long periods. This makes risk highly dependent on the wider economic environment. They generally perform better when growth is steady and company bankruptcies are low, but performance worsens during recessions when defaults rise.

Are high yield bonds less sensitive to inflation?

Compared with government bonds or other low‑yielding debt, high yield bonds are often less sensitive to interest rates. Their higher coupons and shorter maturities help cushion the impact when rates increase.

However, they are more sensitive to economic conditions. Because they sit closer to shares on the risk spectrum, high yield bonds often move in-line with global growth expectations more than they do with interest rates and inflation. 

In periods of rising inflation but resilient growth, high yield bonds can sometimes hold up better than government bonds (gilts) or other low‑yield bonds. This type of behaviour can add balance to a portfolio.

Ways to invest in high yield bonds

 

This is a complex and niche part of global fixed income markets, so unless you’re an investment professional with a very large portfolio, it’s generally unsuitable for retail investors to invest directly into individual high yield bonds.

However, investors looking for the best high yield bond funds in the UK have some straightforward ways to gain exposure to the asset class and benefit from diversification across lots of different individual bonds.

One option is a passive tracker fund or exchange traded fund (ETF), which tracks a high yield bond index at a low cost. These are transparent and efficient, but they take all the risks of the market as a whole.

Alternatively, investors could consider an active high yield bond fund managed by a professional. They aim to outperform the market by avoiding weaker issuers and adjusting exposure as conditions change. This can be particularly valuable in more volatile environments.

Investors can also choose between UK‑focused funds and global high yield bond funds, which spreads risk across regions. Examples include Wellington Global High Yield Bond Fund, part of the Charles Stanley Direct Preferred List – our fund ideas for new investment in the context of the respective sectors – and Man High Yield Opportunities Fund, which is also highly rated by our Collectives Research Team.

Wellington Global High Yield Bond Fund seeks to exploit inefficiencies and beat the broader market by focusing on credit quality and downside protection, often adopting a slightly defensive bias. We expect any value to be added from good credit selection, with perhaps a bit from the ability to adjust overall risk tactically. It provides well-diversified, one-stop-shop exposure to the high yield bond market.

Man High Yield Opportunities Fund is a higher-octane option, which is why it doesn’t occupy the high yield bond berth on the Charles Stanley Direct Preferred List. The managers adjust the level of risk taken more markedly and direct their investment more aggressively to particular areas of the market. It’s therefore more comparable to an equity fund in terms of risk. The manager has proven adept at maximising returns from the asset class in a variety of market conditions, but there will inevitably be times when the focused and differentiated approach doesn’t perform well.

Meanwhile, strategic bond funds offer even more flexibility, allowing a fund manager to move between different types of bonds, including higher yielding bonds, depending on opportunities. These could be a halfway house between harnessing a still-attractive yield from the bond market and aiming to protect on the downside if the environment deteriorates.

However, the manager won’t always get these investment decisions right and investors must understand what the fund is trying to achieve, as well as the level of risk taken. Funds in this sector can vary a lot in terms of objectives and risk. As with any fund, before considering a purchase for a new investment, please ensure you read the fund literature including the Key Investor Information Document (KIID). 

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