economic downturn could be more severe than they were during the past several recessions. In total, given the growing risks present in high yield space, losses for high yield investors during the next U.S. economic downturn could lead to as much as one-fifth of the massive BBB market being downgraded to high yield status, which would likely create ripple effects throughout the high yield markets. Threats are also growing in the area of BBB-rated bonds, the lowest-rated and riskiest category of investment-grade debt. In the leveraged loan space, key threats include the growing influence of collateralized loan obligations and a large share of new “covenant-lite” loans that lack protective investor covenants.
Of particular concern for high yield bonds currently are low interest rate spreads for investors, meaning investors receive little additional return for taking on that extra risk. The persistence of low interest rates since the Great Recession has helped drive demand for high yield credit-high yield corporate bonds and leveraged loans-that offer higher interest rates in exchange for greater risk.
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