Consider a fixed-income portfolio manager holds a coupon bond and later the bond got downgraded, does that mean the return actually increased ? due to the same face value return at the horizon and higher reinvestment income in the middle due to cheaper price of the bond when the grade become lower.
If the bond got downgraded , most likely the price would reflect the downgrade ( if it has not already done so ).
Then the manager who holds the bond will see a loss on the bond ( if he hasn’t lost already ). If price falls and you are long the bond ( i.e. you are the investor ) , you will lose . It is not rocket science. Return cannot increase , only decrease , when a bond you are holding becomes junk.
The higher reinvestment income in the middle comes at the cost of increased risk of default . So you might just be throwing good money after bad
How about when an investor holds the bond until maturity? No loss then… And if the rating agency overreacts or if simply the risk of default does not materialize, you indeed have opportunity to reinvest at higher yields and thus you earn on such an investment more than you would if the bond was not downgraded…
Sure, in an ideal scenario that would happen. However, a downgrade could be an indication of things to come in which the company possibly goes bankrupt or the bonds are downgraded further which make it unlikely to be repaid at maturity. The ability to repay is a gamble you would take reinvesting in a downgraded bond. At that point you are talking about venturing in to hedge fund status investing in distressed securities
Still downgrade does not mean that the bond becomes worthless “piece of paper” automatically…
Nope, just more likely.
You can buy penny stocks and get lucky. You can buy stocks with 10% dividend yield and get lucky. So you could hold on to the junk bond and buy some more as reinvestment, for the extra income, and get lucky.
Anything is possible, including successfully picking up pennies in front of a bulldozer.
Your return does not increase. Not sure where you think you are getting extra income for some sort of reinvestment, as your coupon remains. If you buy at par and it trades down to 80 and carries a 5% coupon, you still get $5. So if you want to use that to buy more of the bond now that its at 80, great, your return on that newinvestment will be higher than the bond you bought at par. But that’s a different investment. It’s like saying if I take my coupon pmt and buy a stock that goes up, that doesn’t increase the return on the bond I bought.
Also, as was mentioned a downgrade is not some sort of death sentence, there’s tons of different ratings levels, would you say a AA to A makes something distressed? The answer is no.
Mr. Leverage, agree with the second part of your post, but strongly disagree with the first one. What is the definition of yield, sir? You do NOT get the yield of e.g. 5% on your bond after N years simply after you collect your N coupons and hide the cash under your pillow 
and then collect the par. You HAVE TO reinvest all your coupons at exactly 5%, and only then your CF from this investment compared to the purchase price will give you 5% in annual terms. So reinvesting coupons is definitely no ‘different investment’…
Of course there are a number of downgrade levels but we are talking in terms of a fixed income portfolio which likely has a limit on what they consider “investment quality” debt ratings. If the downgrade drops the bonds below this mark they are not allowed to buy more and therefore forced to sell the position.
This post is all hypothetical based on the restrictions of the portfolio manager and it’s no different than using a dividend to buy a stock that dropped 20% and lowering the cost basis of the position