Trending
Written by: Behnood Noei & Andrew Okrongly
Key Takeaways
- High-yield bonds have delivered strong returns in recent years with less volatility than equities, providing an attractive risk/reward balance for investors.
- Despite tighter credit spreads, we maintain a constructive outlook for higher-quality high-yield bonds.
- In our view, these issuers still offer historically attractive yields and are better positioned to navigate refinance risk and any potential economic slowdowns.
- Investors should be cautious of strategies targeting “fallen angels,” as a potential downgrade of Boeing and other issuers may present significant concentration risk.
High-Yield Credit Has Delivered Strong Returns, with Less Volatility than Equities
Over the past several years, high-yield bonds have delivered impressive returns, outperforming most other sectors of the fixed income market.
Fixed Income Performance: 9/30/22–9/25/24 (Annualized)
Sources: WisdomTree, FactSet, as of 9/25/24. High-Yield Corporates represented by the Bloomberg U.S. Corporate High Yield Bond Index. Core Fixed Income represented by the Bloomberg U.S. Aggregate Bond Index. Preferreds represented by the ICE BofA Diversified Core U.S. Preferred Securities Index. Investment-Grade Corporates represented by the U.S. Corporate Bond Index. Treasuries represented by the Bloomberg U.S. Treasury Bond Index. TIPS represented by the ICE BofA U.S. Inflation-Linked Treasury Index. You cannot invest directly in an index. Past performance is not indicative of future returns.
This strong performance can be attributed to several key factors, including healthy investor demand, limited net new supply, robust corporate issuer fundamentals and historically low default rates.
Additionally, despite broader macroeconomic uncertainties, high-yield returns and credit spreads (the excess yield offered over Treasuries) have shown remarkable resilience and relatively low volatility.
Rolling Volatility of High-Yield Credit vs. Investment-Grade, Equities
Sources: WisdomTree, FactSet, as of 9/25/24. Based on one-year rolling standard deviation of monthly returns. High-Yield Corporates represented by the Bloomberg U.S. Corporate High Yield Index. Investment-Grade Corporates represented by the Bloomberg U.S. Corporate Bond Index. U.S. Equities represented by the S&P 500 Index. You cannot invest directly in an index. Past performance is not indicative of future returns.
We Remain Constructive on Higher-Quality High-Yield Credit
While the spreads on high-yield bonds have now compressed to relatively low levels, we maintain a constructive outlook on the higher-quality segment of the high-yield market. Here’s why:
By focusing on higher-quality issuers, investors can benefit from the attractive risk-adjusted returns and income offered in high yield, while also mitigating some of the risks associated with lower-rated debt.
Not All “High-Quality” Strategies Are Created Equal
One popular way for investors to access the higher-quality portion of the high-yield universe is through “fallen angel” strategies. These strategies target bonds that were previously rated investment grade but have since been downgraded to high yield.
However, after a period of limited issuer migration, the risk of fallen angels has surged this quarter, particularly due to Boeing’s $57 billion in outstanding bonds, which are under review for possible downgrade by Moody’s.
Notional Value of BBB- Bonds on Downgrade Watch from At Least One of Three Main Rating Agencies
Source: Goldman Sachs Global Investment Research.
While fallen angels may offer enticing yields, the prospects of a Boeing downgrade could dramatically increase the issuer concentration risk in these strategies, some of which have issuer caps as high as 10%!
Given the risks associated with issuer concentration in fallen angel strategies, we suggest that investors consider a broader approach to the high-yield market. Rather than relying solely on credit rating history, we believe it’s prudent to use strategies that systematically identify fundamentally strong issuers across the market.
In summary, the high-yield bond market continues to present a compelling investment opportunity for those seeking strong returns with lower volatility than equities. With careful issuer selection and a focus on quality, investors can still find attractive opportunities in today’s market environment.
Related: The Appeal of Agency Mortgage-Backed Securities in a Shifting Economic Landscape
Important Risks Related to this Article
Past performance is not indicative of future results.
U.S. investors only: Click here to obtain a WisdomTree ETF prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.
WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S.
This WisdomTree article is provided as part of a paid sponsorship.