What history tells us about high yield

Over the course of 2023, many strategists have edged away from their negative view on credit. They seem to have become more constructive on the macroeconomic outlook, and those who believe interest rates have reached a peak are now suggesting an allocation to credit should be increased. The conventional way to express this is an increase in investment-grade bonds.

With this in mind, we have analysed the instances over the last 25 years where the US BBB index (a proxy for investment grade) produced either positive excess, or total returns, and how the US high-yield indices performed during these same periods.

Excess high-yield returns over the risk-free rate

In our view, the results are compelling for high-yield bonds. First, we looked at excess returns (returns produced over the risk-free rate according to ICE BAML indices). We observed that:

• In every year, when BBB has had positive excess returns, so too did BB
• Moreover, BB and B outperformed BBB 90% of the time during the positive excess return years
• Over the same period, BB and B outperformed BBB by an average of 4% in each positive excess return year

The results are summarised below:

Source: ICE BAML Indices, Bloomberg as at November 2023.

Past performance is not a guide to the future. The value of any investment and any income taken from it is not guaranteed and can go down as well as up, and investors may get back less than the amount originally invested.

High-yield total returns

When we looked at total returns, we concluded that:

• In every year bar one, when BBB has registered positive total returns, so too did BB
• BB and B outperformed BBB more than 50% of the time during the positive total return years
• BB and B have more positive annual total return observations than any other rating

Furthermore, the higher-quality segment of high yield (BB and B rated) enjoyed a higher consistency of positive total return years as displayed below, with over 80% of the observations producing a positive return for their investors since 1997.

 Source: ICE BAML Indices, Bloomberg as at November 2023.

Past performance is not a guide to the future. The value of any investment and any income taken from it is not guaranteed and can go down as well as up, and investors may get back less than the amount originally invested.

Why is high yield so unloved?

So why then, when many market commentators typically become more positive on the market, does the recommendation often not feed through to the high-yield area?

We suggest this is down to a persistent overestimation of default rates and the behavioural bias embedded in the asset class, due to the often-misunderstood nature of ‘junk’ bonds. John Ryan, European High Yield Portfolio Manager, has explored this in his recent blog.

If investors have become more positive on credit, then based on historic analysis, the above findings may suggest that high-yield bonds could be included on an asset allocator’s list. The degree of income produced, combined with a greater understanding of behavioural finance, makes high yield an inviting proposition, in our view.