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 SlopeWe’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 HelpDuring 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
Gershon M. Distenfeld is Senior Vice President and Director of High Yield, responsible for all of AllianceBernstein’s US High Yield, European High Yield, Low Volatility High Yield, Flexible Credit and Leveraged Loans strategies. He also serves on the Global Credit, Canadian and Absolute Return fixed-income portfolio-management teams, and is a senior member of the Credit Research Review Committee. Additionally, Distenfeld co-manages the High Income Fund and two of the firm’s Luxembourg-domiciled funds designed for non-US investors, the Global High Yield and American Income Portfolios. He has authored a number of published papers and initiated many blog posts, including “High Yield Won’t Bubble Over,” one of the firm’s most-read blogs. Distenfeld joined the firm in 1998 as a fixed-income business analyst. He served as a high-yield trader from 1999 to 2002 and as a high-yield portfolio manager from 2002 until 2006, when he was named to his current role. Distenfeld began his career as an operations analyst supporting Emerging Markets Debt at Lehman Brothers. He 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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