Assessing high yield bonds as part of your fixed income portfolio

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High yield ribs

The decadent offering of barbecued ribs at a weekend party is similar to that of high yield fixed income investments. By taking on greater risk of spilling sauce on your shirt you have the experience of a true summertime staple, and with high yield fixed income investments you are positioned for potentially higher income. Just like the ribs, you don’t want to overdo it too much on high yield; put a sensible amount on your plate to get a taste of the flavor and little extra yield potential, but not so much that it leaves you feeling queasy from too much volatility.

Market Realist – High yield bond funds offer more returns than either U.S. Treasuries or investment-grade bonds. The above graph shows the returns from iShares 7-10 Year Treasury Bond ETF (IEF), the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG).

High yield bonds have given lower returns this year due to the recent sell-off in the category amid concerns about rising default rates, high valuations, and rising geopolitical tensions.

Market Realist – The graph above shows the high degree of correlation between U.S. equities (SPY) and high yield bonds (JNK). The graph shows the co-movements between the iShares Core S&P 500 ETF (IVV) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG).

According to Del Stafford of BlackRock, the level of correlation between the returns of high yield indices, like the Markit iBoxx USD Liquid High Yield Index (HYG) and the Russell 3000 Index, is as high as 0.74. This means high yield bonds don’t provide diversification benefits in an equity portfolio but may expose investors to the same risk twice over.

Read on to the next part of this series to understand how to incorporate emerging market bonds in your portfolio.

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