The US high-yield market has seen a strong comeback since its panic-driven downturn at the onset of the COVID-19 pandemic. But as today’s economic recovery gathers steam, a new fear has seized investors: rising bond yields.
Investors know that when yields rise, bond prices fall. So, should investors exit the high-yield market to avoid the next rise in yields, and return once it’s behind us? We don’t think so.
In fact, when we explore different investor stances under various yield scenarios, the bond math points to staying invested so as not to get sidelined. Here’s why.
With Bonds, Time (Invested) Is Money
Bonds are sensitive to interest-rate movements, and investors can initially suffer negative returns when yields rise. But if your investment horizon is longer than a few months, short-term losses probably don’t matter that much.
That’s because, when it comes to your bond portfolio, time heals most wounds. Not only do bonds provide income, but their prices migrate toward par at repayment (except in the case of default). That means investors who sit tight will be able to reinvest the principal and coupon income that their portfolios pay in newer—and higher-yielding—bonds. This can offset short-term losses and often increases total return.
Consider the four scenarios in the Display below. In the first three scenarios—rising yields, stable yields and falling yields—the investor stays put in a high-yield portfolio over the full investment horizon. In the fourth scenario, the investor stays out of the high-yield market as yields rise, then enters the market after two years.