Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD), analyzes interest rate risk.
Right now the topic de jour in the fixed income space is interest rate risk. The traditional thought is that as interest rates rise, bond prices fall. But looking at history, the high yield market has defied this widely held notion. Let’s examine the four main reasons why high yield bonds have historically performed well during times of rising interest rates.1
1) Higher coupons and yields in the high yield space help cushion the impact of rising interest rates. High yield bonds, as the name would suggest, have traditionally offered among the highest coupons/yields of various fixed income instruments. The following chart depicts yields, coupons, and the spread over Treasuries for several fixed income asset classes.2
The higher the yield the less the interest rate sensitive the bond, per the duration calculation that we discuss below, and the more income is being generated to offset any impact from a bond price response to interest rate moves.
2) High yield bonds have shorter durations than other asset classes in the fixed income space. Duration is a measure of sensitivity to changes in interest rates that incorporates the coupon, maturity date, and call features of a bond. The fact that high yield bonds are typically issued with five to ten year maturities and are generally callable after the first few years, as well as offer higher coupons, provides the high yield sector with a shorter duration, thus less interest rate sensitivity, versus other asset classes. We’ve profiled some duration comparisons below:3