Chasing High-Yield Bonds? First, Take a Breath

by Daniel Putnam | August 9, 2012 8:30 am

Chasing High-Yield Bonds? First, Take a Breath

Investors in high-yield bonds have been handsomely rewarded in recent years, as a nearly ideal environment of low rates, slow growth and improving corporate performance has propelled the asset class to a huge return advantage over both stocks and investment-grade bonds.

  1-YEAR 3-YEAR 5-YEAR 10-YEAR
Credit Suisse High Yield Index 7.71% 14.40% 8.80% 10.27%
S&P 500 Index 9.13% 14.13% 1.13% 6.34%
Barclays U.S. Aggregate Bond Index 7.25% 6.85% 6.91% 5.65%

Looking back further, the track record for high yield is even more impressive. According to data[1] compiled by Peritus Asset Management — a California-based shop that runs the actively managed Peritus High Yield ETF (NYSE:HYLD[2]) — the Credit Suisse Index not only provided returns in line with the S&P 500 in the 31-year period from 1980-2011 (10.60% vs. 11.05%), but it did so with a much lower level of risk (an annual standard deviation of 9.66% compared with 17.49% for the S&P 500). The results are even better compared to small caps, against which high yield delivered a better return with less than half of the volatility.

In short, high yield has provided investors with a much bigger bang for their risk “buck” than an investment in stocks in the past 30-plus years.

Does this mean investors should blindly buy high-yield bond ETFs such as SPDR Barclays Capital High Yield Bond ETF (NYSE:JNK[3]) and iShares iBoxx $ High Yield Corporate Bond Fund (NYSE:HYG[4]) right now? Not necessarily. Although there still is much to recommend an investment in the asset class, there also are reasons for caution. Below is a look at the pros and cons of investing in high-yield bonds at the moment:

The Pros

hyspread1 Chasing High Yield Bonds? First, Take a Breath[5]

hydefault Chasing High Yield Bonds? First, Take a Breath[6]

ratesensitivity2 1024x413 Chasing High Yield Bonds? First, Take a Breath[8]

The Cons

The Verdict

When all of these factors are taken into account, it seems that the best approach is to wait for the opportunity to get into high yield at a better price. Although the asset class has an outstanding long-term track record, the current risk/reward profile indicates that investors should be well served by exercising a measure of patience.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Endnotes:
  1. data: http://www.peritusasset.com/wp-content/uploads/2010/09/The-New-Case-for-High-Yield-Apr-2012.pdf
  2. HYLD: http://studio-5.financialcontent.com/investplace/quote?Symbol=HYLD
  3. JNK: http://studio-5.financialcontent.com/investplace/quote?Symbol=JNK
  4. HYG: http://studio-5.financialcontent.com/investplace/quote?Symbol=HYG
  5. [Image]: http://investorplace.com/wp-content/uploads/2012/08/hyspread1.png
  6. [Image]: http://investorplace.com/wp-content/uploads/2012/08/hydefault.png
  7. white paper: https://www.alliancebernstein.com/CmsObjectABD/PDF/Research_WhitePaper/LimitedDurationHI_Whitepaper.pdf
  8. [Image]: http://investorplace.com/wp-content/uploads/2012/08/ratesensitivity2.jpg
  9. blog post: http://blogs.barrons.com/incomeinvesting/2012/08/07/junk-bonds-offer-little-hope-of-price-appreciation/
  10. because of massive inflows: http://investorplace.com/2012/05/vanguard-turns-away-non-wealthy-high-yield-hunters/

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