Looking back through history when we have seen rates rise, we have certainly not seen weak returns in the high yield market. For instance, in the 15 years that we have seen Treasury yield increases (rates rise) since 1980, the high yield bond market has posted an average return of 13.7% (or 10.4% if you exclude the massive performance in 2009). This compares to an average return of 4.5% (or 3.6% if you exclude 2009) for investment grade bonds over the same period.3
Intuitively this makes sense because generally rates rise during periods of economic strength, and a strong economy is generally favorable for corporate credit. Historically we have seen the prices of high yield bonds much more linked to credit quality than to interest rates.
For all the chatter that bonds will get hit as rates rise and it is time to move to equities, this historical data would indicate that high yield bonds have certainly not suffered as rates rose in the past. While we currently have our concerns about longer duration asset classes, such as investment grade and municipal bonds, we believe that high yield bonds are positioned well for the rate uncertainty ahead. If rates don’t move much for the year, then you have a much higher starting yield for high yield bonds, and if rates do increase, the high yield asset class has a much lower duration. Furthermore, also including floating rate bank loans in your portfolio can serve to further reduce your duration.
Right now we see many attractive opportunities for investments for active managers in the high yield bond and loan space. There remain over-valued credits and vulnerable credits (such as certain sub-sectors of the energy space) that we would recommend avoiding, but in the mix are also many bonds and loans that offer value for active managers who can select the securities they feel are positioned well for the environment ahead.
1 5-year Treasury rates as of 2/2/15 and 2/17/15.
2 Barclays Capital U.S. High Yield Index covers the universe of fixed rate, non-investment grade debt (source Barclays Capital). U.S. 5 Year Treasury Note is the on-the-run Treasury (source Bloomberg). Barclays Corporate Investment Grade Index consists of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and the quality requirements (source Barclays Capital). Barclays Municipal Bond Index covers the long-term, tax-exempt bond market (source Barclays Capital). Barclays data as of 2/13/15 and Treasury data as of 2/17/15. Yield to Worst is the lowest, or worst, yield of the yield to various call dates or maturity date. Duration is the change of a fixed income security that will result from a 1% change in interest rate. The duration calculation is based on the yield to worst date, using Macaulay duration for the various Barclays indexes and Bloomberg calculated duration to workout for 5-Year Treasury.
3 Data sourced from: Acciavatti, Peter Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “2008 High Yield-Annual Review,” J.P. Morgan North American High Yield Research, December 2008, p. 113. “High-Yield Market Monitor,” J.P. Morgan, January 5, 2009, January 5, 2010, January 3, 2011, January 3, 2012, January 2, 2013, and January 2, 2014. 2008-2012 Treasury data sourced from Bloomberg (US Generic Govt 5 Yr), 2013 data from the Federal Reserve website. The J.P. Morgan High Yield bond index is designed to mirror the investible universe of US dollar high-yield corporate debt market, including domestic and international issues. The J.P. Morgan Investment Grade Corporate bond index represents the investment grade US dollar denominated corporate bond market, focusing on bullet maturities paying a non-zero coupon.