High Yield Bonds: 2014 Mid-Year Update

Since the global financial crisis, high yield bonds have produced some of the best risk-adjusted returns of all asset classes. Global high yield bonds have returned 18.9% since 2008 (on an annualised basis) compared to 15.2% for global equities but with about 45% less volatility¹.

While high yield bonds trailed equities in 2013, they were the best-performing fixed income sector, as they often are in times when bond yields rise. In 2014 equities had a slow start and US government bond yields have dropped, contrary to many investors’ expectations. Over the first five months of this year, global high yield bonds have returned 3.9% (or 9.7% on an annualised basis)².

In this update, James Keenan answers questions about some of the key factors that have been driving high yield bonds’ outperformance, looks at the current markets and what their likely direction should mean for bond investors.

• Favourable market backdrop. An environment characterised by improving economic environment, accommodative central bank policies, strong corporate balance sheets and low default rates is traditionally very supportive of the high yield bond market.
• Lower interest rate sensitivity. Typically, when interest rates rise, the prices of traditional bonds fall. However, high yield bonds are traditionally less sensitive to rising interest rates than higher quality bonds which yield less and, therefore, are affected by changes in interest rates to a greater degree. That is why high yield bonds and floating rate high yield loans have outperformed other areas of fixed income in the six years that rates have risen during the past two decades.
• Attractive risk-adjusted returns. Over the past 20 years, global high yield bonds have returned 1.5% more on an annualised basis than global equities minus a third of the volatility³, making them an attractive alternative to equities. Compared to other types of bonds, high yield offers important diversification benefits, given its low correlation to investment-grade bonds and a negative correlation to US Treasuries.

^{1 Source: BofA Merrill Lynch Global High Yield Constrained Index. USD Hedged, from 01.01.2008 to 31.05.2014.}

^{2 Source: BofA Merrill Lynch Global High Yield Constrained Index. USD Hedged, from 01.01.2014 to 31.05.2014.}

^{3 Source: BofA ML Global HY Constrained Index USD Hedged versus MSCI All Country World Index in USD, from 31.05.1994 to 31.05.2014.}

^{4 Hedged. ‘Global Agg’ = Barclays Global Aggregate Index USD Hedged. ‘Global Corp’ = Barclays Global Aggregate – Corporates Index USD Hedged. ‘Emg Mkt Bonds’ = JP Morgan Emerging Markets Bond Index Global. ‘Bank Loans’ = S&P Leveraged Loan Index. ‘Emg Mkt Equity’ = MSCI Emerging Markets Index. ‘Intl Equity’ = MSCI All Country World Index. ‘US Equity’ = S&P 500 Total Return Index. ‘US High Yield’ = Barclays US Corporate High Yield Index. ‘Global HY’ = BofA Merrill Lynch Global HY Constrained Index USD Hedged. Past performance is no guarantee of future results. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. ‘Commodities’ = Dow Jones-UBS Commodity Total Return Index. ‘Local EMD’ = JP Morgan Emerging Local Markets ELMI Plus Composite Index. ‘Glbl Treasury’ = Barclays Global Treasury Index USD.}