Want to De-Risk? Look to High Yield

May 18, 2022

3 min read

Looking for a tactical way to de-risk your portfolio? You might consider rotating a portion of your equity allocation into high-yield bonds.

Yes, you read that right. It may take a minute to process, since buying high yield is usually thought of as a way to add risk. And with risk assets bearing the brunt of the recent market sell-off, adding risk is the last thing many investors want to do right now.

Here’s what you may not realize: when combined with stocks, high yield can reduce overall risk without sacrificing much return.

Want Lower Volatility? Consider High Yield

In fact, by shifting a modest allocation away from US equities and into US high yield, investors can actually boost risk-adjusted return potential (Display).

High-Yield Bonds and Equities: Effective Complements

Hypothetical Annualized Risk and Return: January 1, 1994–April 30, 2022

Efficient frontier from 100% high yield portfolio through increasing allocation to equities to 100% equity portfolio.

Past performance and historical analysis do not guarantee future results.
As of April 30, 2022
Illustration is based on a hypothetical portfolio; accordingly, such performance is not based upon historical performance of any investment portfolio. This illustration is not intended to provide either a complete analysis regarding any or all of the variables that could affect any particular portfolio. There can be no assurance that an actual portfolio based on the hypothetical portfolio underlying the above illustration could be created or, if created, that it would achieve the results implied above or be profitable. High yield is represented by the Bloomberg US Corporate High Yield Index. Equities is represented by the S&P 500 index. An investor cannot invest directly in an index, and its performance does not reflect the performance of any AB portfolio.
Source: Bloomberg, S&P and AllianceBernstein (AB)

How is this possible?

First, high-yield bonds provide investors with a consistent income stream that few other assets can match. This income—distributed semiannually as coupon payments—is constant. It gets paid in bull markets and bear markets alike. It’s the main reason high-yield investors have historically looked at starting yield as a remarkably reliable indicator of future returns over the next five years—no matter how volatile the environment.

Second, along with these payments, high-yield bonds also have a known terminal value that investors can count on. As long as the issuer doesn’t go bankrupt, investors get their money back when the bond matures. All this helps to offset stocks’ higher level of volatility—and provide better downside protection in bear markets (Display).

When High Yield Draws Down More than 5%, Equities Draw Down More

Past performance and historical analysis do not guarantee future results. Individuals cannot invest directly in an index.
As of March 31, 2022
US high yield is represented by the Bloomberg US Corporate High Yield Index.
Source: Bloomberg, S&P and AllianceBernstein (AB)

Average annualized returns for the Bloomberg US Corporate High Yield Index and the S&P 500 between July 1983 and March 2022 were 8.5% and 11.6%, respectively. But the average drawdown for high yield over that period was 8.3%, around half of stocks’ tally of 14.9% (Display).

US High Yield Has Delivered Equity-Like Returns with Half the Risk

Annualized return for high yield, 8.5%, for S&P 500, 11.6%; annualized volatility for high yield, 8.3%, for S&P 500, 14.9%.

Recovering Losses Quickly

A more typical approach to moderating equity volatility is to reallocate assets to more stable options, such as investment-grade bonds or even cash. But this can exact a heavy cost in sacrificed return potential—especially now that high-yield spreads (the extra yield the bonds offer over comparable Treasury debt) are at their widest since the onset of the pandemic.

As spreads widen, high-yield bonds’ income-generating potential grows, and investors can reinvest their proceeds at higher yields. If volatility eases and spreads start to tighten, that will boost potential returns. If spreads widen further, investors can take comfort knowing that high yield tends to make up its losses more quickly than stocks do.

For instance, over the last 20 years, when the high-yield market suffered a peak-to-trough loss greater than 5%, investors recovered their losses from those drawdowns in just five months on average—and sometimes in as few as two. Meanwhile, stock markets have seen much larger losses and have taken longer to recover from drawdowns.

Of course, it’s still critical to choose your exposures carefully. But over the long run, we’ve seen that adding a dash of high-yield debt to an equity portfolio can tamp down volatility without sacrificing too much return potential. When markets are volatile, that’s a reassuring thought.

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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