Investors often say they’re worried about having too much high-yield bond exposure so late in the credit cycle. But many are still chasing returns in equities and other assets with even higher risk. We’ve got a better idea.
Don’t get us wrong. We recognize how tough it is to generate income in today’s low-yield environment. But as we’ve pointed out before, the best way to boost income potential at this stage in the cycle without also boosting drawdown risk is to have a diversified high-income strategy that embraces multiple sectors and regions.
Today, we fear that too many investors are moving in the opposite direction, taking highly concentrated positions in high-risk assets and sectors in hopes of generating higher returns. Through April 30, investors poured $57.2 million into offshore open-ended mutual and exchange-traded funds that invest in equities, according to Morningstar. But they yanked $14.1 million out of global high-yield funds.
Some investors may not realize that overconcentrating in one asset or sector can expose them to higher-than-expected levels of volatility. The higher the level of volatility, the less predictable return streams are. This means investors may have to rely on larger upswings to make up for losses when they occur.
High-yield bonds and equities are both strongly linked to the business results and fundamentals of the companies they represent, making them both highly correlated with economic growth and the credit cycle. But investors who think they’re de-risking their portfolios by reducing exposure to the former while maintaining it to the latter may be disappointed.
Why? Because high-yield bonds have historically had lower volatility, even during some of the more tumultuous periods for capital markets. And over the long term, high yield has produced equity-like returns with about half the risk of equities (Display).