High yield spreads are historically tight, at levels not seen since the fall of 2007 as the chart below shows, meaning there’s currently a much smaller difference in yield between a high yield bond and a comparable Treasury.
At the same time, some high yield prices have reached all-time highs.
In other words, investors aren’t being rewarded that much for holding high yield, traditionally viewed as a risky asset class.
Does this mean it’s time for investors to abandon high yield? I continue to believe investors should have an allocation to high yield for four reasons:
1.) High yield companies aren’t so junky anymore. Today’s tight high yield spreads are justified given high yield companies’ historically low default rates, which are thanks to an improving US economy, ample liquidity and very strong corporate balance sheets.
2.) All bonds look expensive today. Absolute yields are close to record lows across the fixed income space as a result of continued bond buying by central banks around the world, from the Federal Reserve to the Bank of Japan. But while high yield appears fully priced, it still provides reasonable compensation — versus other fixed income alternatives — over the long term.
3.) High yield has few alternatives. For yield hungry investors, there are few alternatives to high yield considering today’s record low Treasury and sovereign yields.