High yield bonds are no longer rewarding duration and credit risk correctly, argued RWC Partners’ Justin Craib-Cox, and investors should consider using convertible bonds to earn equity-like returns as volatility continues to affect markets.
Following an initial widening, high yield bond spreads quickly tightened in the wake of the initial coronavirus crisis, despite signs that economies have a long way to go and there may be more stress to follow.
With high yield bonds offering under-appreciated risks in the current environment, investors should look elsewhere for debt that has equity-like returns according to Mr Craib-Cox.
“Bond markets are at a turning point, where taking credit and duration risk will not be rewarded as it was in the past,” said Mr Craib-Cox.
“High yield bonds have enjoyed very strong risk-adjusted returns in recent years. That is because the environment has been broadly supportive, thanks to low rates, minimal interest burdens and muted volatility of outcomes. And with investors in need of income and having to allocate more to high yield, it becomes a sort of circular arrangement.
“So why was this period so good for high yield? Simply put, massive monetary support from central banks pushed interest rates lower and dampened volatility, and those conditions helped to limit defaults in high yields while pushing bond prices higher.
“Plus, risk preferences and an aging global demographic created more demand for bonds, providing a steady bid for more speculative credit. In other words, the ...