From Anomaly to Opportunity: High Yields on Short Bonds

March 27, 2023
6 min read

Stock and bond markets were shaken by the recent banking crisis in the US and Europe. Although both US and European authorities took prompt action to prevent damage to the financial system and dampen market volatility, these episodes highlight the importance of risk management and the worth of proven investment strategies that can both mitigate risk and generate worthwhile returns.

Historically, higher-rated short-duration high-yield bonds have provided strong returns with defensive characteristics. Now, with yield curves inverted across North America, Europe and parts of Asia, investors no longer need to increase interest-rate risk (duration) to earn extra income.

Shorter Bonds Make for Lower Risk

Short-dated high-yield bonds are intrinsically less risky than longer-dated counterparts, as their shorter maturities leave them less exposed to both default- and interest-rate risk. Further, as these bonds currently trade below par (Display), their prices will likely rise as they approach maturity, generating capital gains.

Short Duration High Yield at One of the Most Attractive Points in Last 20 Years
Bloomberg Global High Yield Corporate 1-5 Year Index: Starting Annual Price and Yield
These bond prices were lowest in the 2009 Global Financial Crisis (GFC), but 2023 is their second lowest-priced year in 20.

Historical and current analyses do not guarantee future results.
Price and yield for market represented by the Bloomberg Global High Yield Corporate 1-5 Year Index.   
As of February 28, 2023
Source: Bloomberg and AB

What’s more, by concentrating on the higher-quality segment of short-dated high yield, investors can create more defensive portfolios for a relatively small reduction in yield (Display).

High-Quality Short-Dated High-Yield Bonds Have Offered Attractive Yields
Average Yields in US Dollars Over Different Timescales (Percent)
Over one, three, five and ten-year periods these bonds have yielded about 1% less than the global high-yield market.

Current and historical analyses do not guarantee future results.
Indices used are Bloomberg Global High Yield Corporate Index, hedged to US dollars, and US 10-Year Treasury Bond Yield.  
As of February 28, 2023
Source: Bloomberg and AB

Over the 20 years ending September 30, 2022, BB- and B-rated high-yield bonds between one and five years to maturity captured more than 80% of the broader high-yield market return, while experiencing approximately 50% of the average monthly drawdown. Consequently, they have provided better risk-adjusted returns than their longer-dated (five- to ten-year) high-yield counterparts. But they have really come into their own during periods of extreme market stress. At these times, higher-quality, short-duration high yield has exhibited much lower downside capture than both the global and US high-yield markets (Display).

Higher-Quality Short-Duration High Yield Captured Less Downside When Spreads Widened
Cumulative Return When US High-Yield Spreads Widened 50 Basis Points or More (Percent)
In major crises including the GFC these bonds’ prices fell significantly less sharply than US and global high-yield markets.

Past performance does not guarantee future results.
Periods when US high-yield spreads widened 50 b.p. or more. US corporate high-yield returns and spreads are represented by Bloomberg US Corporate High Yield Index; global high-yield hedged returns are represented by Bloomberg Global High Yield Corporate hedged to USD Index; and higher-quality  short-duration high-yield returns are represented by Bloomberg Global High Yield Ba/B 1–5 Year Index hedged USD.
As of February 28, 2023
Source: Bloomberg and AB

In our analysis, dynamically managed short-duration high-yield strategies that can allocate tactically to higher-rated assets, including investment-grade bonds, may achieve even more consistent performance. By varying the allocations to return-seeking and more defensive bonds as market conditions change, investors may have the opportunity both to capture higher returns in risk-on periods and to guard against downside risks in choppier markets.

Inverted Yield Curve Favors Shorter Bonds

Currently, owing to inverted yield curves, investors have a potentially highly attractive entry point for investing in short-duration high-yield bonds, as high-yield bonds with five or fewer years to maturity offer significantly higher yields than longer-dated counterparts (Display).

Shorter-Duration High-Yield Bonds Offer Higher Yields than Their Longer Counterparts
One- to two- year bonds yielded 1.7% more than 10+ year bonds as of February 28, 2023.

For illustrative purposes only. Current and historical analyses do not guarantee future results.
As of February 28, 2023
Source: Bloomberg Global High Yield Corporate Index and AB

In an uncertain world, we think shorter-dated, higher-rated, high-yield strategies could be particularly well-suited to delivering attractive risk-adjusted returns.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to change over time.

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