Still casting about for a New Year’s resolution? If you’re an income-conscious investor, try this: expect that something unexpected will happen next year and act now to cushion your portfolio.
That advice may seem to be at odds with the current mood. Financial markets have decided that the incoming Donald Trump administration means faster economic growth and higher inflation—both good things for higher-yielding, higher-risk assets such as high-yield bonds.
We recognize the potential upside that a strong US economy and some of Trump’s policies present, and we think investors should certainly maintain exposure to high-yielding assets.
But what if everything doesn’t go according to plan? What if Congress balks on some policy details? Or growth doesn’t pick up as quickly as expected? When markets tilt too strongly in one direction, finding your inner contrarian can be good for your portfolio’s health.
DIALING DOWN HIGH-YIELD RISK
Contrarian does not mean pulling out of high yield altogether. A better idea might be to reduce risk by shortening maturities and focusing on quality. Our research has found that over time, high-quality, shorter-maturity bonds capture about 80% of upside moves in the high-yield market, but only about 70% of downside ones (Display).
Why does this combination work so well? First, shorter maturities mean investors are less exposed to rising interest rates and just about any type of unexpected market hiccup. So they tend to hold up better in down markets.