High-yield bonds (HYB): concept and main features, types and recommendations for selection into an investment portfolio

How can a company raise capital to grow its business? Take a loan from a bank. But a bank loan is not always profitable and accessible for small firms. Many companies that do not have a well-known name on the market resort to issuing corporate bonds, and due to the fact that there is no stable brand and fame, the bonds fall into the high-yield segment. Accordingly, the company is forced to offer its creditors a higher risk premium. Why is the company doing this? Perhaps to diversify sources of financing, in some situations a company deliberately issues bonds, and then begins preparing an IPO and issuing shares on world markets.

Should I invest in high yield bonds (HYBs)? These securities offer yields that are several percent higher than OFZs, while the risks of investing in junk bonds are much higher. Default on corporate bonds is a common occurrence; as a result, a novice investor may lose not only his earnings, but also the entire amount of his investment. Is it worth investing in VDO and how to choose a reliable issuer of such bonds on the Moscow Exchange? We will talk about this and more in the article.

Concept and reasons for entering the market

High-yield bonds (abbreviated as HYB) are debt securities with a yield that is sometimes several points, and sometimes several times higher than the market average. The rule works clearly: high profitability = high risk.

The issuers are:

• startups that, for various reasons, cannot get money to implement new ideas and projects;
• operating companies experiencing temporary difficulties and needing to attract additional sources of financing;
• enterprises that were refused a bank loan, for example, due to lack of collateral;
• pre-bankruptcy companies hoping to avoid bankruptcy by injecting money from bond issues.

To attract money to their securities, such issuers have to significantly increase the amount of yield they offer. The investor must be aware that the risk of default (non-fulfillment of obligations) in this case is high.

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VDOs are also called junk or junk papers. If investors were guided only by names, then most of them would avoid investing in garbage altogether. Namely, Tesla, Netflix, CNN, OXY, Anadarko Petroleum Corporation, and others began their journey with the release of VDO.

In the Russian market, VDO is only at the beginning of its journey (from 2021). But the demand for income bonds is steadily growing, and the trend will continue in 2021. The reason is simple - VDOs provide returns significantly higher than deposits, OFZs and bonds of reliable corporate issuers.

In 2021, the market was represented by only three sectors: leasing companies, microfinance organizations and development. In 2021, the picture has become more diverse. The investor has plenty to choose from.

The diagram clearly shows why issuers enter the bond market.

Reasons for the emergence and development of high-yield bonds on the Russian market:

1. Private investors have a demand for high returns, and small capitalization companies are issuing bonds to meet this demand.
2. Previously popular investment instruments have ceased to be profitable: deposits, real estate, currency.
3. Pension reform in the Russian Federation and the realization by the majority of Russians that they need to take care of their future themselves.
4. Increasing financial literacy of the population.
5. Opportunity to open an IIS and take advantage of tax benefits.
6. Development of mobile applications, when you can buy and sell in one click.

Rates have decreased over the 4 years of market development, but remain at a high level:

• 2016: 25 – 33%;
• 2017: 18 – 25%;
• 2018: 14 – 20%;
• 2019: 13 – 18%;
• 2020 (forecast): 12 – 16%.

Look at the chart below to see who is investing in VDOs in the US. In Russia, a similar diagram so far consists of one sector – “Private investors (100%)”.

How to choose a profitable strategy

Based on your understanding of which instruments are the most profitable and reliable, you can choose an investment strategy. In any case, it will be aggressive, since all the tools listed above involve high risks.

But, according to the Pareto rule, 80% of the profit comes from 20% of transactions, so it is recommended to choose at least three instruments. Of course, it may happen that all three selected instruments turn out to be unprofitable, but in most cases it is possible to save at least part of the funds and receive income.

We recommend investing 50% of your funds in an aggressive strategy in instruments that guarantee, at a minimum, the safety of your investments. These are hedge funds and investments in mutual funds (this implies portfolio diversification).

Signs of classifying bonds as high-yield

There are no generally accepted criteria by which a particular bond can be classified as a SDO. Sometimes the same issuer can issue securities with market average yield and high yield. Let's try to identify the signs of classifying bonds as VDO:

1. Issue volume up to 1 billion rubles.
2. Issuers have low ratings or no ratings at all.
3. They are in demand mainly among private investors.
4. The coupon rate is at least 5% higher than the key rate of the Central Bank. As of January 2021, this is from 11.25%. The basis is taken from the provision from the Tax Code, when an increased income tax (35%) is imposed on the excess of the coupon yield over the par value of the bond plus 5%.

For example, on the bond “MyasnichiyTD-BO-P03” the Myasnichiy Trading House pays a coupon of 11.1 rubles 12 times. This is 13.5% per annum. Personal income tax payable will be calculated as follows (for January 2021, the key rate of the Central Bank is 6.25%):

• Taxable base = 1,000 * 13.5% – 1,000 * (6.25% + 5%) = 22.5 rubles.
• Personal income tax = 22.5 * 35% = 7.88 rubles.

You can see examples of high-yield bonds in the screenshot from the website rusbonds.ru. There are representatives of leasing companies (Direct Leasing), transport (GruzovichkoF-Center), microfinance organizations (KarMani), manufacturing (Chelyabinsk corrugated sheet plant, Ebis LLC, which processes secondary non-metallic raw materials), etc. The screenshot is far from a complete list. The entire list of VDOs can be viewed on the website rusbonds.ru or cbonds.ru.

Investments in mutual funds

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Mutual investment funds once became very popular due to the high profits they brought to investors. Such profitability was possible thanks to real estate transactions and investments in high technology.

Nowadays, mutual fund managers are also involved in working with various companies. Those funds that invest trusted funds in bonds and precious metals have good performance.

If the goal is to find a reliable mutual fund, then you should initially count on a moderate percentage of profits. Such organizations use optimal strategies, which reduces profitability.

The average percentage that an investor can count on is 9-14% per month. Almost two thirds of existing funds provide income of 3-4% per month.

When choosing a mutual fund, you need to pay attention to the manager: if he has been working recently, then there is a possibility that the strategy for using the funds received will be aggressive. As a result, profitability indicators may turn out to be high due to the work enthusiasm of the staff. But the risk in this case will also be significant.

Thus, a mutual fund can be safely classified as a high-yield investment. But a stable result will be possible only with a competent analysis of the instrument itself and the manager’s potential.

Types of VDO

There are VDOs:

1. Exchange traded on the Moscow Exchange.
2. Commercial, presented on the over-the-counter market.

A comparative analysis of the two types is presented in the table:

The market volume in the context of exchange and commercial VDOs is visible in the diagrams:

In January 2021, an index for Russian high-yield corporate bonds, Cbonds-CBI RU High Yield, was created. As of January 2020, it includes 60 securities traded on the Moscow Exchange.

Over the entire existence of the index (2 years), the return was 32.74%.

Hedge funds

Such a fund has the structure of an investment partnership. It is led by a manager - the main partner. Background capital consists of investor funds.

A special feature of this tool is its high entry threshold. Based on current legislation, investors who can offer investments from 3 million rubles can participate in hedge funds.

When choosing where to invest money, you should pay attention to such funds for several reasons:

• Extensive investment field. Money can be invested in stock and currency exchanges, land, real estate, etc.
• Possibility of combination with other hedge funds to increase the level of reliability.
• Implementation of various investment strategies.

Such institutions may use many tools to generate profits and change strategies depending on market conditions. This makes a high percentage of capital growth possible.

Recommendations for forming a VDO portfolio

The criteria for selecting VDOs are the same as for bonds with average yield. Basic recommendations for including high-yield securities in your portfolio:

1. Allocate for them a share of no more than 20–30% of assets.
2. Divide the purchase between 8 – 12 issuers.
3. Conduct an analysis of each issuer (demand for products/services, business prospects, stable net profit, low debt load, high share of equity capital compared to debt load, presence of previous technical defaults, litigation, etc.).

VDOs are subject to the same types of risks as regular bonds. But the credit risk of the issuer stands out especially, so this is what you need to concentrate on when choosing bonds.

VDOs can at any time become classified as default securities, i.e. securities for which the coupon payment terms have been violated or have been terminated altogether. It is very important to analyze the issuer's financial statements in order to notice negative trends that could lead to default.

Let's use the example of the GruzovichkoF-Center issuer to see whether it deserves inclusion in the investment portfolio. There are no reports for 2021 yet, so let's look to 2021. The best place to look for information is the Corporate Disclosure Center.

Let's draw some conclusions.

• The Financial Results Report shows that the company's revenue decreased by 36,768 thousand rubles. Net profit increased by 288 thousand rubles.

• The balance sheet shows that the company's total debt has increased sharply: from 85,049 thousand rubles to 290,960 thousand rubles. The debt burden is 63 times the size of total capital.

• The company does not have credit ratings, although it has not yet committed any technical defaults.
• The debt load is high, the leverage ratio is 0.98, while the recommended value is less than 0.7.

Leverage Ratio = Liabilities / Assets = 290,960 / 295,563 = 0.98

• The ratio of net debt to EBITDA (ND/EBITDA) is 3.2, with the recommended value not exceeding 2. It also indicates the company’s high debt load.

Based on the results of such an express analysis, I concluded for myself that the bond from the GruzovichkoF-Center company will not be included in my portfolio. I don't like many financial indicators. To get a more objective picture, you need to analyze the financial statements for several years and look at the company over time.

Best brokers

You should choose brokers from among the major representatives. They offer competitive commissions with a high level of service. In addition, they are much more reliable than smaller players.

Rick Keith Opening CapTrader Exante

The oldest Russian broker, operating since 1994. An excellent choice for those who want to connect to autofollow. Pros:

• no annoying calls with offers to spend money;
• own trading platform;
• impressive results of strategies (+74% for 2021) that you can connect to.

Of the minuses:

• no Quik.

You can read the full review here.

A good broker for a beginner. Here I hold the Russian part of the investment portfolio from an ETF from FinEx on an IIS.

The broker pleases:

• low commissions and the absence of annoying calls with offers to spend my money.

Of the minuses:

• weak personal account and inconvenient system for annual key regeneration.

The review can be read here.

Another great broker with whom I worked for more than 2 years. This is where I traded on FORTS.

Pros:

1. Reasonable commissions
2. Excellent personal account
3. Nice free services

The downside is the broker's love of calling people trying to sell something.

The review can be viewed here.

German IB introducing broker for direct access to foreign markets. This is where my investment portfolio is located.

Pros:

1. Works with Russians
2. Availability of a Russian-language version of the site
3. Reasonable commissions
4. No inactivity fee
5. Insurance under US law for $500k

The disadvantages include:

• Support exclusively in English and German
• The support service itself is poor

For a detailed review, see this post.

Another interesting broker for going abroad, and not from the IB family. Unfortunately, contracts are opened for Russians only in Cyprus.

Pros:

1. Acceptable commissions
2. The fact of successful verification of work by the SEC
3. Russian-language website and support

On the downside:

• Cyprus jurisdiction
• Inactivity fee

Read a detailed review here. You can get a $500 bonus when opening an account here.

Definition of the term

Highly profitable investments are cash injections into projects that bring profit in a very short period of time, from several days to a month. The yield exceeds the annual average for classical financial instruments (deposits, bonds, shares).

In practice, high-yield investments bring from 60% to 200% per annum, which is at least 5 times higher than the return on bank deposits (≈12%).

There is no investment without risk. Despite the high reliability of projects, at any stage of the transaction the investor risks his own funds.

Cryptocurrency

If the goal is to find the most profitable investments, then Bitcoin must be used without fail.

It is worth investing in cryptocurrency for the following reasons:

• Stable rate growth.
• Inflation protection. Thanks to the structure of the code, Bitcoin will not depreciate.
• Independence from governments, banks and other external structures.
• Greater liquidity. Bitcoin can be exchanged for a variety of goods and services.
• Popularity. Many investors have already invested in cryptocurrency and its capitalization continues to grow.

In addition to purchasing coins, you can invest money in mining and generate bitcoins.

Investing in blockchain-based startups can be a source of high income. There are many similar projects, and there is plenty to choose from. As a result, such a direction as working with cryptocurrency and blockchain makes it possible to receive high profits from several sources. It's profitable and safe.

Peer to peer lending

Investing in P2P platforms can bring good profits. We are talking about lending to small and medium-sized businesses at an interest rate favorable to the investor. Sometimes this figure is 120% per annum.

The lending process can be carried out using online platforms where the investor and the borrower meet.

Equal lending as a tool for multiplying capital has 3 tangible advantages:

• Does not require personal participation of the investor. All you need is to provide your funds, the rest will be taken care of by the specialists responsible for the operation of the P2P platform.
• Legal and transparent. Reporting and all necessary documents are located in the investor’s personal account.
• Moderate risks. The solvency of companies acting as borrowers is always checked.

In addition to this tool, you can use microcredit, which is also a popular way to get high profits.

How much money will be required for high profit projects?

Just a few years ago, the word “investor” was associated with rich people and seemed unattainable. With the development of globalization, anyone has the opportunity to invest money in a large investment project and receive their share of the profits. Usually the minimum investment amount starts from $300. Agree, the amount is quite reasonable and, most importantly, the loss of this money in case of unsuccessful investment can be experienced quite calmly. But if the outcome is positive, a nice bonus of $150 won’t hurt at all.

Qualification is useful

The law adopted on May 19, 2021 by the State Duma at the instigation of the Bank of Russia, limiting the ability of unqualified investors to purchase bonds without ratings or with low ratings, will have virtually no effect on the VDO market, according to its participants. According to Bobovnikov, almost 100% of Ivolga Capital clients who invest in VDOs have qualified status.

The same statistics were confirmed by Zibarev. “Those who for some reason are unqualified are now receiving qualifications,” he clarified. — So nothing terrible will happen for the VDO market with the adoption of this law. We are not expecting collapse."

“We support the efforts of the Bank of Russia to categorize investors,” Bobovnikov stated.