All investors need to focus on the expected return of an investment.  Price movement is certainly a piece of this, but history has indicated that much of those long term returns in fixed income and equity investing have come from yield.  In bond investing, an incredible amount of information on yield is published by various funds and managers and can be confusing to many investors.

However, we view the yield-to-worst (meaning the yield to the worst return outcome, outside of a default, in holding a bond, which is generally the first call or maturity) as a good proxy to assess the potential return.  In the high yield bond market, it is amazing to see how many investors and advisors continue to purchase the passive funds without any consideration of this metric.  So much emphasis is placed on fees and trading volume that they have forgotten what it is these funds own and ignore the starting yield they provide.

In analyzing the yield-to-worse, corporate bond investors must deal with the “callability” of their bonds.  This means that after a certain period of years following issuance (typically three or four years) the bonds can be called by the company.  They are generally called because the company can refinance them cheaper and/or the company feels there is an opportunity to extend the maturities.

While investors usually receive a call premium (we typically see this premium start at $104 or $105, then declining to $100 as you get closer to maturity), they also lose the bonds and must redeploy the proceeds, often in a lower rate environment.  What we have seen over the past couple years is that many bond prices have traded to premiums well above their call prices (known as negative convexity), meaning investors will suffer principal losses upon a call or maturity.