Of course, more risk also equates to higher expected returns. What’s interesting to me is how these different asset classes deliver return to investors. When an investor moves from Treasury bonds to investment grade corporates, they are taking on an increasingly high level of default risk and are being compensated with higher expected yields. When an investor goes from high yield to developed market equities they actually receive a lower expected yield but a higher expected price appreciation, which results in a higher expected return.
What’s the bottom line for how investors should think about high yield? As an asset class that offers some of the largest yields in fixed income markets high yield can play a role in generating income for a portfolio, but investors should be mindful of the increased risk relative to many other fixed income sectors. High yield’s best role is as a source of income in a broadly diversified portfolio.
Full disclosure: Tom Lydon’s clients own HYG.