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Portfolio > Investment VIPs

High-Yield Bonds: Only for Long-Term, Non-Squeamish Investors

By Ginger Szala

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High-yield bonds are in the eighth year of an investment cycle that has seen assets under management grow threefold, to $300 billion, so interest among investors remains high. And according to three high-yield bond experts speaking at the Morningstar Investment Conference in Chicago, the cycle will continue to expand, presenting global opportunities for investment. 

Moderator Sumit Desai of Morningstar began the panel discussion Tuesday by framing high-yield bond growth and volatility, both in performance and assets. For example, the US OE High Yield bond fund has a total YTD return of 5.66%, but a negative 2.34% return over the past year. More interesting is the return on the BofA Merrill Lynch U.S. High Yield Energy Bond index, which has a whopping 18.26% return YTD, but over the past year still has a negative 15.65% return.

“How do high-yield bonds fit into a diversified portfolios? Investors are looking for stability and diversification as a safety net against equities…but some correlation [between bonds and stocks] lately creates confusion,“ Desai asked. 

“The main thing an investor should think about is their time horizon when looking at this asset class,” responded Fred Hoff, portfolio manager for Fidelity Management and Research Co.  “This asset class has a high level of current income, and every academic study has shown if you hold your portfolio over long period, you could get yield of 8% a year over five to 10 years.”

Michael Hong, portfolio manager at Wellington Management Co. concurred:  “A long view of high yield is attractive, especially because income return is high.”

Mark Vaselkiv, portfolio manager at T. Rowe Price, noted that “Einstein said there were three great forces of nature: gravity, electro magnetism, and compounded interest…high yield is an asset class that ultimately capitalizes on the latter.  In this market generating 7%-8% per annum, over 20 years is significant; $100,000 invested in a high-yield fund 20 years ago is worth $400,000 today. I agree that you take a long-term view with this asset. “ 

Desai said that high-yield bonds also mean high risk, and pointed to the volatility of high-yield energy bonds, especially in the past year. The panel wasn’t overly worried about that shorter-term volatility, largely due to their position that high-yield should be seen as a smart long-term investment. 

“The impact of energy going forward is less exciting than the last 24 months,” Hoff said. He added that the price of oil falling $100 per barrel, and then rebounding to the high $40s shook out the market, noting that if the price goes to $30 again it definitely will impact yields. “Today there are a lot of survivors. Energy is still 13% of the market. We’ve seen smarter companies take advantage of the rebound: we’ve seen them issue convertible bonds, issue equity…The number of risky high-yield companies is down. Today people are more realistic with oil prices. “ 

Vaselkiv pointed out there was a “game changer” in February this year when “Moody’s took a chainsaw to $150 billion of investment-grade oil and gas bonds, and downgraded very high-quality investmen- grade companies to BB,” which he noted was a one-time opportunity to prove the strength of their portfolios. He also said there could be come consolidation, which would strengthen some strong bond issuers like Exxon.

Hong noted he was now  “bullish on MLPs.”

As long-term investments, many factors that roil the stock or even broader bond markets don’t affect high yield, the panelists pointed out. For example, Hoff noted the volatility caused by a possible Brexit hasn’t affected his key investments in health care and cable company high-yield funds. Also, his fund only invests in products that are dollar denominated, so they don’t have any currency risk.

Vaselkiv admitted that liquidity was a challenge in certain markets, like energy, where it was tough to find product to buy.  However, when product might be tight, his firm looks globally. Right now he says Brazil is a worthy buy because there are some strong companies despite the country’s credit markdown. That said, he reported much of his fund’s international investments are in Europe.

“Some people criticize European high yield” because their upper yields offer 3%-4%, “but some world class companies carry 8%” Vaselkiv said. “Brexit could cause significant volatility, but I see that as a buying opportunity, like the European cable company Liberty Global, which will  deliver significant cash flows no matter what happens. “ 

Another issue Desai posed to the panel was whether  passive investing like ETFs will impact high-yield mutual fund’s growth in assets. Hong noted ETFs were best for short-term investing, and that high yield was definitely for active investing.

Hoff said his fund discouraged those types of investors by charging high back-end fees because “they hurt the returns.”

Vaselkiv put it another way. High-yield investors are “made up of permanent residents and tourists,” he said, and “and we take advantage “ of the tourists.

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