We continue to find a number of reasons for a positive outlook on the high-yield bond sector. First, the long-term average spread in the high-yield market is close to 500 basis points, so today high-yield spreads are at above-average levels. But at the same time, the fundamental backdrop for high-yield corporate bonds continues to be quite strong, with record earnings for publicly traded companies and large amounts of cash on corporate balance sheets.

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Over the long term, the reason high-yield bonds offer a spread advantage is to compensate investors for the risk of default. Historically, that par-weighted default rate has been 4.2%. However, today the market has a par-weighted default rate of 1.9%, which is well below the long-term average, and we believe that trend is likely to continue over the near term.

Looking back at historical default patterns in high-yield investing, there have tended to be rather prolonged periods of below-average defaults following a spike in the default rate. The last signifi­cant peak occurred in November 2009, when defaults exceeded 13%.

Many of today’s businesses that survived the crisis are running very lean organizations, with strong balance sheets and historically large levels of cash on hand. In the current economic environment — which represents a significant improvement from the depths of the recession and financial crisis in 2008 and 2009 — we believe that the companies within the high-yield universe should be able to continue to grow their businesses and that the default rate, as a result, ought to remain low.

Today, in our view investors are being paid more than usual in the form of higher yields for assuming below-average default risk.

Read our perspective on second-quarter fixed-income opportunities and risks below or download as a pdf.

Funds that invest in bonds are subject to certain risks including interest-rate risk, credit risk, and inflation risk. As interest rates rise, the prices of bonds fall. Long-term bonds are more exposed to interest-rate risk than short-term bonds. Unlike bonds, bond funds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk.