Reaching for Yield: Worth the Risk?

Investors seeking more robust returns in a lower-interest-rate environment often look to high-yield bonds for answers. But it’s critical that they don’t reach too far down the credit spectrum in search of higher yields—as tempting as it may be.

High Yield’s Slippery Slope
We’re currently in the stable phase of the credit cycle—characterized by companies’ solid financial health—and we anticipate that we’re still years away from increasing defaults becoming an issue. But that doesn’t give investors the green light to begin stretching for higher yields by investing in lower-rated credits.

The display below shows cumulative five-year default rates, which worsen the further one slides down the credit scale. Even reaching for CCC-rated debt can put an investor in hot water and often isn’t worth the pain, as the compensation isn’t commensurate with the risk level. The extra premium investors receive is low relative to history—on top of default risk—and CCC debt is unattractively priced above par. Bottom line: avoid the yield stretch. How Roll Can Help
During a steep-yield-curve environment in which interest rates are expected to rise, yield-curve “roll,” or a bond’s price increase as it moves closer to maturity, can act as a cushion against rising rates and declining prices. Over time, a bond’s yield progresses—or rolls—down the yield curve as its price ticks upward. Bondholders can especially benefit if interest rates rise by less than anticipated, as their bonds will likely be valued at a higher level than new issues of a comparable time frame.

Many credit curves are particularly steep today, creating opportunities for roll. The display below shows how roll can work for a five-year corporate credit default swap (CDS). For the bond’s total return (its income and capital appreciation) to be eroded, interest rates would have to rise by 200 basis points, which is unlikely.                                       

Given the current environment, we expect high yield to continue its journey for the next couple of years, and as long as investors remain wary of yield stretch, and remember that roll is on their side, they’ll have a better chance of successfully navigating the road ahead—no matter what interest rates do.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Gershon M. Distenfeld, CFA

Director—High Yield and Investment-Grade Credit
Gershon M. Distenfeld is Senior Vice President and Director of High Yield and Investment-Grade Credit at AB, responsible for overseeing the investment strategy and management of all investment-grade and high-yield corporate bond portfolios and associated portfolio-management teams. Strategies under his purview span the credit and risk spectrum, from short-duration investment-grade corporate bond portfolios to regional and global high-yield portfolios, encompassing a range of investment approaches, objectives and alpha targets, from income-oriented buy-and-hold strategies to active multi-sector total return strategies, and including both publicly traded securities and private placements in developed and emerging markets. Distenfeld also co-manages AB’s award-winning High Income Fund, recently named “Best Fund over 10 Years” by Lipper from 2012 to 2015, and the award-winning Global High Yield and American Income portfolios, flagship fixed-income funds on the firm’s Luxembourg-domiciled fund platform for non-US investors. He also designed and is one of the lead portfolio managers for AB’s Multi-Sector Credit Strategy, which invests across investment-grade and high-yield credit sectors globally. Distenfeld is the author of a number of published papers, including one on high-yield bonds being attractive substitutes for equities and another on the often-misunderstood differences between high-yield bonds and loans. His blog “High Yield Won’t Bubble Over” (January 2013) is one of AB’s all-time most-read blogs. Distenfeld joined AB in 1998 as a fixed-income business analyst, and served as a high-yield trader (1999–2002) and high-yield portfolio manager (2002–2006) before being named Director of High Yield in 2006. He began his career as an operations analyst supporting Emerging Markets Debt at Lehman Brothers. Distenfeld holds a BS in finance from the Sy Syms School of Business at Yeshiva University, and is a CFA charterholder. Location: New York.

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