Volatility has seemed to be the trend in markets over the past couple months. It was just a few weeks ago that we saw equity markets getting crushed, only to roar back and actually finish up for the month of October and back near all-time highs. It makes no sense to us that investors have no problem dealing with volatility in stocks, “investing for the long run,” as the stock market has historically gone up, but with the high yield asset class, we often see the “risk on” or “risk off” mentality, meaning investors think they should either be fully invested or out of the market altogether.
In reality, over the long-run high yield bonds have actually performed relatively equivalent to equities (as measured by the S&P 500 index), with nearly half of the volatility, or “risk,” as measured by the standard deviation. This has led to risk adjusted out performance (return/risk) over the history of the high yield market:1
People seem to often view the high yield market as an all or nothing trade, with its attractiveness merely based on short-term measures. Yet we believe its true attractiveness is the steady income it provides, in both up and down markets, and potential for price appreciation/capital gains. As we look at the high yield market today, the recent re-pricing of the market over the past few months has created what we see as exceedingly attractive opportunities for yield, as well as discounts (pricing below par and call prices) that we have not seen in some time in many names, allowing for more potential opportunities to realize capital gains.
What many investors don’t grasp is that you can actively position businesses and industries in a fixed income portfolio the same way you can equities. The difference is that we get paid every day as our securities accrue interest and we have finite outcomes via stated maturities2, which helps us remain patient. So why not collect the regular income generated (coupon payments) and enjoy a market that has historically had nearly half the volatility as the stock market?
1 Credit Suisse High Yield Index data from Credit Suisse. S&P 500 numbers based on total returns. Calculations based on monthly returns and standard deviation is calculated by annualizing monthly returns. Return/risk is based on annualized total return/annualized standard deviation. The Credit Suisse High Yield Index is designed to mirror the investible universe of the $US-denominated high yield debt market. Use the links below to download index data and constituents. The S&P 500® is a market-value weighted index of 500 selected common stocks, most of which are listed on the New York Stock Exchange. It is widely recognized as representative of the equity market in general. Values based on monthly compounding.
2 Bonds and loans have stated maturity dates as the ultimately outcome, barring a security default. However, there may be reasons that a bond or loan is taken out earlier, such as due to early calls or tenders at premium prices. Actual results may differ materially from the stated maturity.
This article was written by Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisory firm of the AdvisorShares Peritus High Yield ETF (HYLD).