Three Reasons Why US High Yield Belongs in Your Portfolio
Looking for a way to increase your US exposure without adding equities? Need more income but worried about rising rates? US high-yield bonds deserve a place in your portfolio.
The high-yield market has had a good run over the last few years—so good, in fact, that some investors may be wondering whether it’s time to cut their holdings. We don’t think it is.
If you want diversified exposure to the US economy, high-yield bonds have an important role to play. Here are three reasons why:
1. HIGH-YIELD BONDS ARE A GREAT SUBSTITUTE FOR US STOCKS. Most investors consider high-yield bonds part of their fixed-income allocation. But they act more like stocks. This is because, like stocks, high-yield bonds are strongly linked to the business results and fundamentals of the companies they represent.
There’s one important difference, though. Over the long run, high yield has produced equity-like returns with half the volatility of stocks (Display). With US equities valuations looking stretched, now may be the ideal time to stir some high yield into the mix.
Of course, high-yield bonds aren’t cheap today, either. Credit spreads—the extra yield these securities offer over comparable government bonds—have narrowed and the market is in the final stages of one of the longest credit cycles in history.
But here’s the rub: history has shown that US high-yield bonds lose less than US stocks during downturns and recover those losses more quickly. A big reason for that is high yield’s steady stream of income—in the form of semi-annual coupon payments—that gets paid in bull and bear markets alike. And as long as an issuer doesn’t go bankrupt, investors get their money back when the bond matures.
Are stocks and high-yield bonds overdue for a correction? That’s hard to say. But when a correction does come—and corrections are not unusual for either asset—we expect high-yield to hold up better and rebound first. In other words, a portfolio that mixes in high yield should provide better protection.