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By   Farris G. Shuggi, CFA

Exploiting Durable Inefficiencies in High Yield Debt

Seeking to capture value from dislocation in high yield bonds.

June 2025, From the Field

Key Insights
  • Despite the broad characterization, not all high yield debt is created equal. 
  • Supply and demand imbalances in the high yield bond market contribute to a consistent opportunity to buy BB bonds at a discount. 
  • By understanding where investors are compensated for risk across and within asset classes, capital can be allocated in pursuit of superior risk-adjusted returns.
View Transcript

High yield bonds are thought by many to be a speculative, higher-risk asset. But within high yield, BB bonds have historically generated almost equity-like returns with lower volatility and better risk-adjusted returns. So how have these bonds, which are often characterized as “junk,” provided such great performance over time? 

BB bonds are the first credit tranche that is high yield debt.

When a bond is downgraded from a BBB credit rating, which is the last tranche of investment grade, to BB, it has often resulted in forced selling of that bond by investors who cannot hold non-investment-grade debt. These sellers have often included entities such as pension funds, insurance companies, and investment-grade institutional investors.

This forced selling has caused the price of BB bonds to decline and their option-adjusted spread to increase significantly. That increase in spread is the extra compensation above the risk-free rate that an investor expects to earn for the potential risk of default.

On average, a BB bond has earned about a 150- basis-point higher spread than a BBB bond, but the risk of default over a one-year period was only 0.5% higher, and the overall risk of default was just 0.7%. In other words, less than 1% of U.S. BB bonds have historically defaulted in any given year on average.

Thus, an investor could seek a significantly higher yield by taking on what has been only a very marginal increase in default risk. It is this asymmetry that has led to the great risk-adjusted returns for BB bonds.

                 

Farris G. Shuggi, CFA Head, Quantitative Equity
Jun 2025 From the Field

Exploiting Durable Inefficiencies in the Equity Options Market

By  Farris G. Shuggi

Important Information

Where securities are mentioned, the specific securities identified and described are for informational purposes only and do not represent recommendations.

This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, nor is it intended to serve as the primary basis for an investment decision. Prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.

The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.

Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources’ accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date written and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.

The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.

It is not intended for distribution to retail investors in any jurisdiction.

This material is only for investment professionals that are eligible to access the T. Rowe Price Asia Regional Institutional Website. Not for further distribution.

© 2025 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, the Bighorn Sheep design and related indicators (see troweprice.com/ip) are trademarks of T. Rowe Price Group, Inc. All other trademarks are the property of their respective owners.

202508-4702505

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