Investors are often led down the path that they must invest in equities in order to generate a decent return, and that the high yield market is too risky and speculative. However, reality and the data points prove otherwise. Looking over the past couple decades and various periods in between, you can see that high yield has consistently outperformed the equity market (as measured by the S&P 500 Index) on a risk adjusted basis (return/risk).1
Here, risk is defined as standard deviation, or volatility of returns. What is even more notable is that the high yield market outperformed equities over the 10- and 15-year periods on a pure return basis, even without adjusting for the fact that the high yield market carries less risk. Even taking into account the enormous technology and internet rallies of the late 1990’s, high yield bonds have performed only slightly lower than equities over the past 25 years, but with about 40% less risk (standard deviation).
Looking at that “riskiness” of the high yield asset class in another way, investors need to remember that in a company’s capital structure, equities fall below bonds, no matter the bond rating (investment grade or high yield). This means that in any sort of difficult situation, the bonds get paid back first. Further, as the data above shows, high yield bonds have much lower risk as measured by volatility (annualized standard deviation), giving high yield bonds what we see as a significant return/risk advantage.
The data speaks for itself: it seems to be time for investors to reconsider their sizable allocations to the equity market and instead, consider an increased allocation to the high yield bond market. And with the advent of high yield exchange traded funds, accessing the high yield market is now available to retail and institutional investors alike.
1Credit Suisse High Yield Index is an index designed to mirror the investible universe of the $US-denominated high yield debt markets. Credit Suisse High Yield Index data sourced from Credit Suisse. The S&P 500 Index is a broad-based, unmanaged measurement of changes in stock market conditions based on the average of 500 widely held common stocks. S&P 500 index data sourced from Bloomberg, using a total return including dividend reinvestment. Annualized Total Return and Standard Deviation calculations are based on monthly returns. Return/Risk calculated as the Annualized Total Return divided by Annualized Standard Deviation.
This article was written by Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD).