The Bank of England has a useful inflation calculator that underlines this risk, showing how prices have changed between 1209 and 2020. Due to the high levels of inflation in the 1970s, for example, you would have needed £360.74 to buy goods in 1980 valued at £100 just 10 years earlier. Although the government tends to raise interest rates to help keep inflation under control – and interest rates were much higher in the 1970s – the current yield of about 0.8 per cent on 10-year gilts (UK government bonds) would mean a £100 investment would result in a total return of roughly £8 if held to maturity, including the original outlay.
https://www.bankofengland.co.uk/monetary-policy/inflation/inflation-calculator
The sensitivity of a bond’s value to interest rates is known as duration risk, which is measured in years. Investment grade bonds are typically longer and have higher duration risk as the holders receive a higher proportion of the total value of these assets when the principal is redeemed. Non-investment grade bonds tend to have shorter maturities (generally less than 5 years) than their investment grade counterparts, and the holders derive bigger portion of the total value from the higher yield. There is an inverse relation between prices of bonds and interest rates. As interest rates increase bond prices tend to go down and vice versa.
High yield bonds usually become more popular during periods of economic growth, when there is greater potential for price appreciation as the improving backdrop reduces the likelihood of default. Increased earnings, lower debt burdens, upgrades to credit ratings and merger & acquisition activity can also boost their value. Governments also tend to raise interest rates during periods of economic expansion, and the lower duration of non-investment grade bonds, along with the factors mentioned above, means they tend to outperform their investment grade counterparts in these conditions.
However, they sell off quickly during recessions due to the heightened risk of default, with investors flocking to investment grade bonds for their capital-preservation qualities.
As a result, the risk/return profile of high yield bonds can more closely resemble that of equities rather than other types of debt, offering diversification benefits to a fixed income investor. It is worth remembering though that in the event that a company is liquidated, any money owed to bond holders is prioritised over that of shareholders.
You can read Dimitry Griko’s first article here.
