Returns at different risk levels

It's widely known that the return you earn is a function of the risk you take. Higher risk equals higher return. Lower risk equals lower return. But what is high and what is low? How do we determine a high return vs. A low return? That is heavily influenced by prevailing market conditions.

Back in 2012, Morgan Stanley (an A- rated / investment grade rated company) had a 7.3% 2019 bond in issue. A few local investors shunned this bond in favour of a slightly higher yield on the junk or B- rated GOJ 8% 2019. At the time, it was possible to get 7% on an investment grade rated credit or close to 8% on a high-risk bond. Fast forward to 2021, GOJ bonds are yielding anywhere from 3% to 4.5% and Morgan Stanley bonds are yielding between 1% and 3%. The returns you get for the same risk are much lower in 2021 than they were in 2012.

Knowing the returns associated with different risk levels can help you gauge the risk of a new investment that you are considering. For example, if you see an investment yielding 9% in the current environment, that should be a red flag – regardless of what the investment advisor is telling you. Below, we list the yields that are available on bonds in different risk categories of US$ bonds:

1. “Low Risk” bonds or “investment grade” credits are yielding around 1.46%[1]. This includes companies such as: Apple, Amazon, Toyota. It also includes low risk sovereigns such as the US Government. In fact, the yield on US Government bonds is widely referred to as a “risk free rate”, meaning it theoretically represents the safest yield available in the market. A 10-year US Government bond was yielding around 1.34% on Thursday August 26, 2021.
2. “Medium Risk” is perhaps the hardest to define. For the purposes of this article, we define medium risk as credits that are rated between BB+ and BB-. A rough indicator of yield here is 3.08% (I.e., the weighted average yield on the BB Index on Bloomberg). Think companies like Netflix, Sirius XM Radio, YUM! Brands (owner of KFC, TACO BELL, Pizza Hut), Bath & Body Works, Ford Motors.
3. “Medium to High Risk” is defined as anything in the B category – which was yielding around 4.49% on Thursday August 26, 2021. Think companies like: Uber, New Fortress Energy, Government of Jamaica, Jaguar Land Rover Automotive, Bed Bath & Beyond.
4. “High Risk” (for the purposes of this article) is defined as CCC or lower. The CCC index on Bloomberg is yielding around 6.49% as at August 26, 2021. This is a weighted average, and the dispersion is especially wide in this category. Think companies such as Bombardier, AMC Entertainment (I.e., the movie theatre chain). Digicel is also in this rating category (although it is not in the index used as an example).

These yields are not hard and fast. There are always exceptions and outliers. They are simply meant to give you a guide for where the market is right now so that you can know what is a reasonable return to expect based on your risk appetite

Marian Ross is Vice President, Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in U.S. dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm

Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm

[1] Using the weighted average yield to worst on the “US Aggregate” Index on Bloomberg