Yield Matters in Bond Investing

Anxious investors then prompted the creation of issuer-constrained (or “capped”) market-weighted indexes. The issuer cap appeared to provide some benefit to investors, however, it also served to undermine a core historical investor attraction of the asset class — access to the potentially generous yields afforded by higher risk, higher yielding debt securities.

The New Frontier Fixed income can play two important roles in portfolios — diversification and income generation as defined by yield. Analysis by Northern Trust Asset Management of the Bloomberg Barclays High Yield Index (“Index”) indicates that yield returns contributed 111% of overall total returns as opposed to price returns, which contributed a negative 11% between December 1993 and April 2018. The analysis shows that in seeking to maximize the value of high yield, investors may benefit from a focus on maximizing exposure to yield.

The next frontier in high yield may be applying the lessons gleaned from earlier versions of high yield ETFs towards a yield maximization strategy. This evolution calls for seeking to provide yields/returns above those offered by market-weighted high yield strategies. This is achieved by using innovative security selection and weighting methodologies that focus on maximizing factor inputs for the yield value factor, while controlling for quality and liquidity risk.

Such yield-focused product outcomes are achievable today using current generation investing tools and techniques. One such product, the FlexShares High Yield Value-Scored Bond Index Fund (HYGV), seeks to track the performance of an underlying index to achieve above risk adjusted, market-weighted yields by maximizing the yield value factor while screening for credit quality and liquidity risks.

The high yield market has evolved immensely since its “junk bonds” days into a respected investment option. Unfortunately, mainstream high yield morphed into a more quality focused and lower yielding investment. By focusing on the value factor while concurrently screening for quality, investors may be better served by this updated strategy that combines contemporary approaches with the keystone principle of high yield investing: focusing on the “yielding” aspects of high yield.

Mark Carlson, CFA, is senior investment strategist for FlexShares ETFs, is a member of the FlexShares investment strategy team, and responsible for fixed income and natural resource strategies.