The corporate high-yield market has gone full circle over the past 15 months. Starting in early June 2015, the market began to struggle with the negative implications of a downtrend in the price of oil. That struggle turned into a rout as fears of defaults sent yields rising steadily until mid-February 2016. The yield on the BofA Merrill Lynch High Yield Master Index rose from 6% on June 1, 2015, to 10% in mid-February 2016, as defaults increased sharply among the energy sector’s weakest credits. As energy prices steadied and the generous yields sparked strong demand, that yield declined to below 6.5% by late August 2016.
Credit sectors
After this full yield cycle, it’s helpful to examine the performance record of credit and maturity sectors. It is not surprising that the CCC-rated high-yield corporate bonds and weaker credits were the most volatile—suffering a 25% negative return during the sell-off and then producing a 38% return since mid-February of this year. That has been a typical cyclical pattern; the weakest credits decline the most and then rebound more than the BB and B sectors. From February 2015 through August 2016, however, the BB credits produced the best total return. Investors in the CCC sector experienced far greater volatility but less return than owners of the BB credits.
That return pattern has also held over longer investment horizons. Over the 2000–2016 period, the BB index has recorded an annualized return of 8.4%, while the B and CCC index returns have been 7.4% and 7.8%, respectively. The market has not benefited investors for accepting the incremental credit risk and greater volatility inherent in the B and CCC categories.
Maturity segments
Because the junk bond yield curves were relatively steep over the past 15 months, investors earned better returns from the longer maturities. Returns increased from 4.1% for the 1- to 3-year maturity segment to 6.2% for the 7- to 10-year segment, to 9.7% for the 10+ year segment. The 1- to 5-year segment—which could be used to represent a short-term high-yield portfolio—produced a return of approximately 4.5%. The 5- to 10-year segment—which could be used to represent most bond funds—recorded a return of 6.0%. The full market index recorded a return of 4.9%.
Adjusted for duration, however, returns from the longer maturities lag those from the shorter maturity segments. The 1- to 5-year indexes produced approximately 225 basis points (100 basis points equals 1.00%) of return per year of duration, which was almost twice the duration-adjusted returns from the 5- to 10-year and 10+ years maturity segments.
Conclusion
This return history makes a strong case for shorter-duration high-yield funds with BB average credit quality. The fact that yields are back to June 2015 levels—at a time when the Federal Reserve is expected to resume raising the federal funds rate—may enhance the appeal of a conservative short-term fund, depending on one’s goals, risk tolerance, and time horizon. To be sure, the performance of “junk” or non-investment grade bonds has not been highly correlated with movements in the federal funds rate or the Treasury market. But after the strong rally of the past six months, the “junk” or non-investment grade market probably has lost some of its ability to withstand a rise in short-term rates. Thus, the shorter maturities could be expected to continue to produce better risk-adjusted returns than the longest maturities.
High-yield market total returns as of 8-22-16
|
Credit sector |
6-1-15 to 2-15-16 |
2-15-16 to 8-22-16 |
6-1-15 to 8-22-16 |
|
BB |
-7.6% |
15.5% |
5.4% |
|
B |
-13.5% |
19.2% |
2.4% |
|
CCC |
-25.2% |
37.7% |
3.0% |
|
Maturity segment |
6-1-15 to 2-15-16 |
2-15-16 to 8-22-16 |
6-1-15 to 8-22-16 |
|
1- to 3-year |
-7.6% |
14.9% |
4.1% |
|
7- to 10-year |
-10.4% |
17.8% |
6.2% |
|
10+ year |
-11.8% |
28.2% |
9.7% |
Source: Bloomberg
Past performance is no guarantee of future results.
Please visit our blog, AdvantageVoice, for additional viewpoints from Wells Fargo Asset Management’s investment strategists, portfolio managers, and practice management experts. You can also follow us on Twitter at @WFAssetMgmt for real-time updates. Are you an advisor or institutional investor? Check out our website for investment professionals.
The views expressed are as of 8-29-16 and are those of James Kochan, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the authors and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.
Wells Fargo Asset Management (WFAM) is a trade name used by the asset management businesses of Wells Fargo & Company. Wells Fargo Funds Management, LLC, a wholly owned subsidiary of Wells Fargo & Company, provides investment advisory and administrative services for Wells Fargo Funds. Other affiliates of Wells Fargo & Company provide subadvisory and other services for the funds. The funds are distributed by Wells Fargo Funds Distributor, LLC, Member FINRA, an affiliate of Wells Fargo & Company.
Not FDIC Insured • No Bank Guarantee • May Lose Value
© Wells Fargo Asset Management
