A High-Income Survival Guide for Late-Cycle Markets
It’s easy to get spooked in late-cycle markets. But we think there’s a way to de-risk your portfolio and still generate a decent level of income—no magic spells necessary.
Investors often do one of the following things when markets are in the later stages of the credit cycle:
- Some react to slower growth and falling interest rates by stretching for more yield in CCC-rated corporate bonds, preferred stocks or other higher-risk, lower-quality assets. And they often do it by investing in concentrated, single-sector strategies that lack diversification.
- Others shy away from return-seeking credit assets altogether, accepting less income in exchange for better protection against large drawdowns.
The way we see it, neither approach stands much chance of helping investors reach their goals. The first exposes them to too much risk—likely with inadequate compensation—while the second is bound to limit income potential and may not reduce risk by as much as people think.
What’s the alternative? Simple: globalize your high-income strategy and look for opportunities across fixed-income sectors. This diversifies a portfolio, which increases income potential and reduces downside risk. Both are important because the risk associated with “risk assets”—high-yield bonds, equities, leveraged bank loans and so on—varies considerably.
Not All Risk Assets Perform Equally
Put another way, some risk assets are riskier than others. Take high-yield bonds, a building block of any high-income strategy. Over time, high-yield performance has more in common with stocks than other types of bonds, but with one important difference: it’s about half as volatile.
As Display 1 shows, global high-yield returns were not far below those from the MSCI World Index of global stocks over the past decade. And they comfortably outpaced what a 60/40 stock-bond portfolio delivered. But high yield offered more downside protection and was less volatile than either one, giving it a higher risk/return ratio.