Happy New Year!
Since we launched our blog last September, we have received a lot of positive support. We sincerely appreciate you taking time out of your day to read our thoughts on the market.
Below, we have highlighted our three most popular blog posts from 2019. If you have a topic you would like for us to cover, please contact us. We appreciate your feedback.
Cheers to a new decade!
Consistent cash return that compounds over time
In a previous blog post, High Yield: Are Its Returns Too Closely Correlated to Equity for it to be Considered an Allocation to Fixed Income?, we analyzed performance data since 1998 and illustrated how on average, high-yield bonds performed in line or better than large cap equities on a rolling three- and five-year basis. Further, the volatility of high-yield bonds has been considerably lower than equities, resulting in stronger risk-adjusted performance. Observe the following long-term performance and risk statistics of high-yield bonds versus large-cap equities and small-cap equities, as shown by the S&P 500 Index and Russell 2000 Index, respectively, for the time period 4/1/1998 to 9/30/2019:
The high yield bond market1 has generated impressive returns – up 12.07% – through the first eleven months of 2019. However, examining the returns for a market in aggregate can be deceiving, as it can mask significant dispersion of returns within different segments of such market. Year-to-date performance of the high yield bond market in 2019, as well as the twelve-month period ending 9/30/19, is one of these periods. In particular, the return differential of the BB-rated segment as compared with the CCC-and-below rated segment, and the resulting relative valuation of these segments, is historically unprecedented.
In May of this year, the yield spread between 3-month U.S. Treasury Bills and 10-year U.S. Treasury Notes turned negative (i.e., yields on 3-month U.S. Treasury Bills were higher than yields on 10-year U.S. Treasury Notes). This phenomenon is known as a yield curve inversion. Since the 1960s, an inverted yield curve has preceded each recession, without producing a false signal. While the curve is no longer inverted as of the date of this post, it remained so until mid-October.
This week, we continue with our third and final educational piece on high yield bonds and bank loans. In the first two parts of this blog series, we discussed where each type of debt typically sits in a company’s capital structure; the size and growth of the bank loan market; useful statistics with respect to each asset class (such as volatility measures); and why the flexibility to invest in both asset classes can enhance the long-term risk-adjusted returns of a high yield portfolio. Links to these blog posts are available at the bottom of this page.
“From the (data), one can see that the inversion period ended seven months before the 2007 recession; six months before the 1990 recession; and only two months prior to the 2001 recession.”
In May of this year, the yield spread between 3-month U.S. Treasury Bills and 10-year U.S. Treasury Notes turned negative; in other words, the yield curve inverted. The curve remained inverted until mid-October. Historically, this phenomenon has proven to be a useful leading indicator of a recession. However, while it is true that the yield curve has inverted prior to each U.S. recession dating back to the 1960’s without producing a false flag signal, there appears to be little to no information embedded in this signal that predicts the timing of the recession that follows. Admittedly this missing information is a very important piece. Be that as it may, if we assume that the indicator will once again correctly predict a coming recession, we thought that it would be worthwhile to examine how the high yield market has historically reacted to this event and whether there is a useful pattern to be uncovered as it relates to such market’s overall performance.
High yield bonds and bank loans are two asset classes that are more alike than many investors realize. In the first part of this blog series, we discussed where each type of debt typically sits in a company’s capital structure, and why the flexibility to invest in both bonds and bank loans in a high yield portfolio can enhance the risk-adjusted returns of such a portfolio over time.
This week, we will be discussing the size and growth of the bank loan (aka leveraged loan) market, as well as other useful statistics, such as volatility measures, of loans as compared with high yield bonds.
High yield bonds and bank loans are more alike than many investors realize. Although there are meaningful differences between the two types of securities, from an investment perspective, we believe that these two asset classes should be viewed through the same lense. As we will expand on, we believe an investment manager that focuses on both segments together can create considerable value for a high yield portfolio. Furthermore, having one analyst team that focuses on both asset classes is the way to go instead of having separate specialists.
In May, the yield spread between 3-month U.S. Treasury Bills and 10-year U.S. Treasury Notes turned negative; in other words, the yield curve inverted. Historically, this phenomenon has proven to be a useful leading indicator of a recession. However, while it is true that the yield curve has inverted prior to each U.S. recession dating back to the 1960s, without producing a false signal, there appears to be little to no information embedded in this signal as to the timing of the recession that follows. Admittedly, this missing information is a very important piece.
In previous blogs (Is There a Right Time for High Yield, part 1 and part 2), we suggested that high yield appropriately deserves a place in an investor’s overall strategic asset allocation. However, a common argument that we hear against such a decision is that it bears too much of a resemblance to an investment in equity. High yield has been described as a hybrid asset class; i.e., it displays the characteristics of both equities and fixed income. In fact, high yield does display a higher correlation to equities, and those who would not otherwise recommend an allocation to high yield may say that an investor could instead obtain a similar diversification benefit with higher potential returns simply by adding to an existing equity allocation.
