CONTRIBUTORS
Bill Zox, CFA
Portfolio Manager,
United States
Some compare high yield risk to equities while others liken it to core fixed income. A look at performance shows high yield (HY) often has a resilience and risk-adjusted return potential all its own.
Exhibit 1: Growth of $1: Comparative Performance of US High Yield
US$. December 31, 2021–June 30, 2024
Sources: Bloomberg (© Bloomberg Finance LP), FTSE Russell, ICE BofA. Analysis by Brandywine Global. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
Imagine it is the first day of 2022. I tell you that over the next two and a half years, through June 30, 2024, the Russell 2000 Index of small-capitalization U.S. stocks is going to decline -5.4% and the Bloomberg US Aggregate Bond Index (the “US Aggregate Index”) is going to decline -8.9% on a total return basis. Based on that knowledge, you now have to forecast the US high yield market over the same time period as measured by the ICE BofA US High Yield Index (the “High Yield Index”). What would your forecast have been? Probably not positive 3.4%, which was the actual result. Of course, we do not have the luxury of knowing in advance what other risk assets are going to return. However, high yield’s outperformance is striking, nonetheless. How could that be?
It was not due to the starting valuation, since the High Yield Index spread was 310 basis points, the yield-to-worst was 4.3%, and the dollar price was over 103 cents on the dollar. Two and a half years later those metrics were 321 basis points, 7.9%, and just under 93 cents on the dollar, respectively. Instead, the answer lies in the resilience of the high yield asset class due to its lower duration and higher stated interest rates than most of fixed income.
The duration of the High Yield Index was around 4 years at the beginning of 2022. The market repriced dramatically in the first half of 2022 as base interest rates increased materially and investors forecast a high probability of recession. On a total return basis over that 6-month period, the High Yield Index was down -14%, the Russell 2000 was down over -23%, and the US Aggregate Bond Index was down over -10%. By the middle of 2022, the spread of the High Yield Index was close to 600 basis points, the yield-to-worst was close to 9%, and the dollar price was less than 86 cents on the dollar. For the two years from June 30, 2022, the High Yield Index was positive 20.2%, the Russell 2000 was positive 23.5%, and the Aggregate Index was positive 1.7%.
As is typically the case, the price of the high yield market adjusted rapidly to new information. The low duration then meant substantial cash—interest payments, calls, tenders, maturities—could be reinvested at the new, more attractive yields. The Russell 2000 fared better than the High Yield Index for the two years from June 30, 2022, but it was not enough to offset the larger drawdown in the first half of 2022. The Aggregate Index was slightly positive for that two-year time period through June 30, 2024, but suffered from lower interest payments and much higher starting duration. While the High Yield Index clearly benefited from a benign credit environment, the index’s resilience has been demonstrated in severe credit cycles as well.
In the opening weeks of the third quarter of 2024, the Russell 2000 has made up more than half of its underperformance compared to the High Yield Index. But the High Yield Index has also performed well as the increase in US equity market value supports credit quality and access to capital in the high yield market. Some perceive high yield risk to be equity-like, others more like core fixed income. We believe the reality, as we saw in this period, is that high yield is especially resilient, often generating compelling risk-adjusted returns compared to stocks or core fixed income over time.
Definitions:
One basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).
The Bloomberg US Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.
The ICE BofA US High Yield Index tracks the performance of U.S. dollar-denominated below investment grade corporate debt publicly issued in the major domestic markets.
The Russell 2000® Index, which is a subset of the Russell 3000® Index, measures the performance of the small-cap segment of the US equity universe. It includes approximately 2,000 of the smallest securities based on a combination of market capitalization and current index membership.
Yield to worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Past performance is no guarantee of future results.
Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.
US Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.