Why high-yield bonds can once again be a sensible portfolio addition 


Why high-yield bonds can once again be a sensible portfolio addition 

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Author - Harald Besser

Having removed high-yield bonds from the portfolios since Russia's invasion of Ukraine in February 2022, we are now starting to add them in our portfolio again. The reason for this are long-term positive economic expectation and a decline in inflation. High yields are a relevant component in any bond allocation, as they have higher return potential than investment grade bonds and are also less correlated with them, so they can bring good diversification.

High yield bonds are bonds with a rating below BBB-, higher rated bonds are called investment grade bonds. The rating refers to the probability of default of a bond. The more risky a security is rated, the higher the coupons (i.e. the interest) paid on these securities. 

Growing market

The global high yield market has 3700 individual securities with an equivalent value of around USD 2.5 trillion, as measured by the Bloomberg Global HY Index. The average remaining maturity is 6.2 years with a yield of 8.6%. For euro issues, yields are around 7% and in USD 8.2%. These figures vary greatly depending on the risk category and are further reduced by expected default rates. In this context, a default is also not always one at 100% but depending on the recovery rate. In 2022, high yield yields have risen with those of U.S. Treasuries and may now have peaked. This development is seen as a very positive signal for corporate America and the economy.

The role of high yields in the portfolio

High-yield bonds form a key component of our bond portfolio when the economic outlook is positive. As a result, they have not been in our bond portfolio since the invasion of Ukraine in February 2022. This positioning is now starting to change gradually, and we now have a 1.5% weighting of European high yield bonds again. High yields not only have higher return potential than investment grade bonds, they are also less correlated with them. High yield bonds are therefore a good diversifier in the bond portfolio.

Should the economic environment and inflation expectations continue to improve, we would expand this positioning. In general, however, we never recommend high-yield bonds as a single position, but only as a broadly diversified portfolio, as the default risks here are too high. In terms of yield, yield spread and default rates, high-yield bonds are more attractive than they have been for a long time, although caution is still warranted in view of the general economic situation, inflation and central bank measures.

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