If you’ve been investing for a while, you’ve probably heard the phrase — don’t put all your eggs in one basket. That’s what diversification is all about. And when it comes to fixed income, one of the ways investors try to do this is by adding high yield funds to their mix.
These funds can bring in stronger returns compared to traditional debt investments. But before you dive in, it helps to understand how they work, what they offer and where the risks lie.
What are high yield funds?
High yield funds are mutual fund schemes or debt funds that invest in bonds issued by companies with lower credit ratings. These are not the safest companies out there but many of them are growing fast or belong to sectors that operate with higher financial risk.
Because the bonds carry more credit risk, they also come with higher interest payouts. So when you invest in a high yield fund, you’re pooling your money into a basket of such bonds, and the fund manager takes care of selecting and managing them.
It’s not the same as buying a single bond. Here you get exposure to a bunch of them through one fund.
Why do investors consider high yield funds?
The most obvious reason is better returns. High yield funds aim to generate higher income by tapping into the extra interest that these bonds offer. So if your regular debt fund is giving 6 to 7 percent, a high yield fund might give you 9 to 11 percent depending on the market and the quality of bonds held.
Another reason is access. Not everyone wants to spend time researching companies or reading bond documents. High yield funds offer a way to get exposure to this space without having to go bond shopping on your own.
That said, for those who prefer more control, some investors now choose to buy bonds online and build a similar portfolio themselves. Both approaches have their place, depending on how hands-on you want to be.
But what about the risks?
This part is important. High yield funds carry more credit risk than other debt funds. If one or more companies in the fund face trouble, it can affect the overall return. Defaults, delays and downgrades can happen.
There’s also interest rate risk. Like all debt funds, the value of high yield funds can drop when rates rise. And since these funds hold lower rated bonds, they can be more sensitive to market swings.
Another thing to watch is liquidity. Some of the underlying bonds may not be easy to sell in tight market conditions. While the fund structure gives you daily liquidity, the exit price may be lower if the market mood is negative.
How to use them in your portfolio
High yield funds should not make up your entire fixed income allocation. Think of them as a satellite holding. They work well when paired with more stable assets like government bonds or top rated corporate bonds.
Make sure to check the fund’s past track record, portfolio quality and how it manages risk. Look at the credit rating mix and avoid funds that go too heavy on ultra low rated debt just to chase returns.
Also, stay updated. Even if you are not managing the bonds directly, it’s your money. Know where it’s going.
Final thoughts
High yield funds offer a way to stretch your returns, but they come with extra risk. If you’re looking to balance your portfolio and don’t mind a bit of volatility, they can be a useful tool.
For some, they serve as a passive way to benefit from the high yield space. Others may prefer to buy bonds online and customise their exposure. Either way, the key is to be aware, informed and realistic about what to expect.
Returns may be higher but so is the responsibility of staying alert. Diversification works best when it’s built with care. High yield funds can play a part in that — if you use them wisely.
