Volatility: High Yield Bonds Versus Equities

By Peritus Asset Management

Volatility has once again returned to financial markets over the last few months, most visibly with wild equity price movements that we saw in February and again in late March.

While the high yield bond market certainly has not seen the extent of the volatility the equity markets saw, the rise in the 10-year Treasury yield has been an overhang in high yield as many are concerned about interest rate risk for fixed income securities.

While we believe this concern is valid for lower yielding, longer duration sectors (like investment grade corporate or municipals), high yield bonds have historically performed well in rising rate environments, helped by the fact rate increases generally correspond with improving economies.

This often tends to alleviate credit risk, and high yield bonds benefit from their shorter maturity and higher yield, thus lower duration versus other fixed income alternatives (see our writing “Strategies for Investing in a Rising Rate Environment” for further detail).

Generally speaking, fundamentals for corporate credit remain solid and default rates are expected to remain low over the next couple years, which we feel positions the high yield market nicely. Thus these periods of volatility like we have seen over the last couple months can create opportunities when they aren’t driven by a weakening credit environment/elevated credit risk.