Junk Bond

A junk bond, more politely called a high-yield bond, is a debt instrument issued by a company or entity with a credit rating below investment grade. In India, credit ratings are assigned by agencies like CRISIL, ICRA, CARE, and India Ratings. A bond rated below BBB- (or equivalent) is considered non-investment grade or "junk."

These bonds offer higher Interest Rates (yields) than investment-grade bonds to compensate investors for the greater probability of default. While a AAA-rated corporate bond might yield 7.5%, a BB-rated bond from a stressed company could yield 12–15% or more. The spread between junk bond yields and risk-free government bond yields is called the credit spread, and it widens during economic downturns when default fears increase.

In the Indian context, the high-yield bond market is less developed than in the US. However, corporate defaults by companies like DHFL, IL&FS, and Reliance Capital have highlighted the real risks of lower-rated debt. SEBI has introduced regulations for credit rating agencies including enhanced disclosure norms, rating transition studies, and stricter conflict-of-interest rules following these high-profile defaults.

Investors access high-yield debt in India primarily through credit-risk debt Mutual Funds (previously called "credit opportunities funds"). These funds invest in lower-rated bonds seeking higher returns. However, the Franklin Templeton debt fund crisis of April 2020 — where six schemes were wound up due to illiquidity in their high-yield holdings — served as a stark warning about the liquidity and credit risks in this space.

For individual investors, junk bonds should constitute only a small allocation (5–10% of the fixed-income portfolio at most) and only via diversified mutual funds. Direct investment in individual high-yield bonds carries concentrated default risk that can result in permanent capital loss.