Strategy Time... (a revisit to high yield corp bonds)

High yield bonds offer investors attractive income in the current environment, with an average yield of more than 600 basis points greater than the yield on government bonds.

So, why is it important for investors to include an allocation to high yield bonds in their portfolio?

1. Enhanced Diversification - High yield bonds are often considered a distinct asset class, as they involve different return characteristics and have a lower correlation to traditional asset classes such as Government bonds and equity. For this reason, adding high yield bonds can increase portfolio diversification, and potentially reduce risk and enhance returns.

2. Attractive Income Potential - With interest rates at low levels, most investors cannot generate the income they require by investing in government bonds alone. Generally speaking, high yield bonds pay higher interest rates than investment-grade and government bonds to help compensate investors for the additional risks of investing in lower quality bonds. Over the life of a bond, those higher coupons provide a higher rate of return than higher quality (investment grade) bonds.

High yield bonds offer investors attractive income in the current environment, with an average yield of more than 600 basis points greater than the yield on government bonds.

3. Capital Growth Potential - In a recovering economy, companies who issue high yield bonds can see their debt rating upgraded due to improved cash flow, offering investors the potential for capital appreciation from the associated increase in the bond’s price. Historically, high yield bonds have tended to provide equity-like returns, but with much lower volatility – a characteristic that many investors are currently looking for.

4. Less Sensitivity to Interest Rates - High yield bonds tend to be less sensitive to interest rate fluctuations than most fixed income securities, primarily because they carry a higher coupon and have terms of 10 years or less. In addition, high yield bond prices react more to credit spreads and changes in credit quality than interest rates.

What’s the outlook for high yield bonds?

We believe conditions remain extremely favorable for high yield bonds. Weak demand, particularly from consumers is providing an environment of slow but positive economic growth, low interest rates and low inflation. Corporations, having cut costs and delevered balance sheets during the credit crisis, are showing strong profit growth but only marginal revenue growth. As a result, leverage across the corporate sector remains low, and cash has been building to record levels. Credit quality, as measured by balance sheet strength is at record levels and corporate default rates are headed towards new lows.

With yields on traditional income producing investments at record lows, investors are increasingly looking to high yield bonds to provide steady, sustainable cash flows. In addition, many investors have been unnerved by the extreme volatility of equities in recent years, with high yield bonds offering an attractive, less volatile alternative. As a result, flows into the sector from both institutional and retail investors continue to grow, putting downward pressure on spreads.

How are we incorporating them in our client’s portfolios? (A study)

All portfolios reflect the clients individual risk tolerances, goals and requirements, so we sit with each and build out a strategy on a case-by-case basis. However, from a macro view, parts of client’s portfolios that are focused around a 100% equity mandate have benefitted greatly from scaling back (say 25%) and reallocating to High Yield.

The chart below shows the 15 year return of the S&P 500 along with the 15 year return on the US High Yield Index. Interestingly, High Yield outperformed by over 8%, but with substantially less volatility during that period.

For clients scaling back to a 25% High Yield / 75% Equity portfolio - the average annual return bettered the 100% Equity portfolio by around 2.2%. ***And it did so at 25% less volatility.

How does one best invest in this asset class?

It is important to view High Yield Corporate Bonds in a similar risk category as equities. (I commonly refer to them as a “stock in bonds clothing”.) So, I do not look to include them in the Fixed Income portion of client’s portfolio profiles, but rather towards the overall equity portion.

There are a number of ways to participate in High Yield: directly buying the bonds from the issuer, buying the index through various ETFs, or buying units of a High Yield fund. All 3 are great ways, but are unique and dependant on the requirements of the client. **Questions such as Cost, Liquidity, Diversity (market and sector), and Manager Risk are all part of the decision process.

Here are some examples:

iShares IBOXX Hi Yield Index ETF (HYG)

Costs 0.5% MER
The 3 year return 9.36%
The 3 year index return was 10.41%
Small tracking error for this ETF
Current Yield: 8.17%

Marret High Yield Fund (MHY.UN)

Barry Allen – Fund Manager
Costs 1% MER
Average duration – 3 yrs.
Since inception (June 2009) return 10.51%
Current Yield: 7.34%


The High Yield market in Canada is quite small, with most new issue allocations going towards the institutional investor, so looking towards a managed or indexing approach would provide access to much broader markets for the individual investor.

As always, contact your investment advisor to see if this asset class is an appropriate fit in your current portfolio.

Best Regards and Safe Investing.

Eric.