Recent reports show that yields for California high-yield bonds may increase to as much as 6 percent by the middle of 2010. Despite this yield increase (which represents higher potential returns), those making investments are not convinced that they should buy in because of California’s poor economic state.
What Are High-Yield Bonds?
If you’re not familiar with high-yield bonds, they are also known as high-yield debts, and are bonds that are rated below investment grade at their time of purchase. Inherently, they bring with them a higher risk of default – or other adverse credit events – because you are investing in debt that is to be paid back in a predetermined period of time.
Because they pose so much risk, investors usually get paid higher yields than better quality bonds.
The Deal with California’s High-Yield Bonds
Kenneth Naehu, is a major investor who invests $2.5 billion for Bel Air Investment Advisors in Los Angeles. Late last year, he sold his California high-yield bonds late last year because he saw the state’s deficits mounting.
He, like others making investments, is very skeptical of California’s economy, which right now is $20 billion in the whole and possibly looking to pass out IOUs for the second year in a row, not to mention it having $73 billion in general obligation debt outstanding.
However, Gov. Arnold Schwarzenegger and two-thirds of the Legislature are trying to agree on way to fix the economy and if they can, they hope to sell billions of dollars in bonds.
Should Investors Take Advantage of the Higher Yields?
Some wonder if they should take advantage of these bonds that are bringing in higher yields in comparison to municipal bonds – currently there is a gap between the two yields in the ballpark of 3.15 percent. However, there is an inherent risk involved in buying into high-yield bonds as opposed to other bonds that have a great likelihood of promising a return.
Right now, there is no guarantee that the state will be able to pay back the debts owed as promised with the possibility that it will have to pass out IOUs for the second year in a row. So if you’re concerned at all that making investments in the state’s bonds could pose a risk to your assets, you may want to follow Naehu and just wait before making a decision.