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 1. From Anomaly to Opportunity: High Yields on Short Bonds

 
Income Invest for Efficient Income Rising Rates Fixed Income Blog


FROM ANOMALY TO OPPORTUNITY: HIGH YIELDS ON SHORT BONDS

March 27, 2023
6 Minute Read

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Gershon M. Distenfeld, CFA | Co-Head—Fixed Income; Director—Credit
Will Smith, CFA| Director, US High Yield
Robert Schwartz| Portfolio Manager—High Yield


Stock and bond markets were shaken by the recent banking crisis in the US and
Europe. Although both US and European authorities took prompt action to prevent
damage to the financial system and dampen market volatility, these episodes
highlight the importance of risk management and the worth of proven investment
strategies that can both mitigate risk and generate worthwhile returns.

Historically, higher-rated short-duration high-yield bonds have provided strong
returns with defensive characteristics. Now, with yield curves inverted across
North America, Europe and parts of Asia, investors no longer need to increase
interest-rate risk (duration) to earn extra income.


SHORTER BONDS MAKE FOR LOWER RISK

Short-dated high-yield bonds are intrinsically less risky than longer-dated
counterparts, as their shorter maturities leave them less exposed to both
default- and interest-rate risk. Further, as these bonds currently trade below
par (Display), their prices will likely rise as they approach maturity,
generating capital gains.

Short Duration High Yield at One of the Most Attractive Points in Last 20 Years
Bloomberg Global High Yield Corporate 1-5 Year Index: Starting Annual Price and
Yield

Historical and current analyses do not guarantee future results.
Price and yield for market represented by the Bloomberg Global High Yield
Corporate 1-5 Year Index.   
As of February 28, 2023
Source: Bloomberg and AB

What’s more, by concentrating on the higher-quality segment of short-dated high
yield, investors can create more defensive portfolios for a relatively small
reduction in yield (Display).

High-Quality Short-Dated High-Yield Bonds Have Offered Attractive Yields
Average Yields in US Dollars Over Different Timescales (Percent)

Current and historical analyses do not guarantee future results.
Indices used are Bloomberg Global High Yield Corporate Index, hedged to US
dollars, and US 10-Year Treasury Bond Yield.  
As of February 28, 2023
Source: Bloomberg and AB

Over the 20 years ending September 30, 2022, BB- and B-rated high-yield bonds
between one and five years to maturity captured more than 80% of the broader
high-yield market return, while experiencing approximately 50% of the average
monthly drawdown. Consequently, they have provided better risk-adjusted returns
than their longer-dated (five- to ten-year) high-yield counterparts. But they
have really come into their own during periods of extreme market stress. At
these times, higher-quality, short-duration high yield has exhibited much lower
downside capture than both the global and US high-yield markets (Display).

Higher-Quality Short-Duration High Yield Captured Less Downside When Spreads
Widened
Cumulative Return When US High-Yield Spreads Widened 50 Basis Points or More
(Percent)

Past performance does not guarantee future results.
Periods when US high-yield spreads widened 50 b.p. or more. US corporate
high-yield returns and spreads are represented by Bloomberg US Corporate High
Yield Index; global high-yield hedged returns are represented by Bloomberg
Global High Yield Corporate hedged to USD Index; and higher-quality 
short-duration high-yield returns are represented by Bloomberg Global High Yield
Ba/B 1–5 Year Index hedged USD.
As of February 28, 2023
Source: Bloomberg and AB

In our analysis, dynamically managed short-duration high-yield strategies that
can allocate tactically to higher-rated assets, including investment-grade
bonds, may achieve even more consistent performance. By varying the allocations
to return-seeking and more defensive bonds as market conditions change,
investors may have the opportunity both to capture higher returns in risk-on
periods and to guard against downside risks in choppier markets.


INVERTED YIELD CURVE FAVORS SHORTER BONDS

Currently, owing to inverted yield curves, investors have a potentially highly
attractive entry point for investing in short-duration high-yield bonds, as
high-yield bonds with five or fewer years to maturity offer significantly higher
yields than longer-dated counterparts (Display).

Shorter-Duration High-Yield Bonds Offer Higher Yields than Their Longer
Counterparts


For illustrative purposes only. Current and historical analyses do not guarantee
future results.
As of February 28, 2023
Source: Bloomberg Global High Yield Corporate Index and AB

In an uncertain world, we think shorter-dated, higher-rated, high-yield
strategies could be particularly well-suited to delivering attractive
risk-adjusted returns.



The views expressed herein do not constitute research, investment advice or
trade recommendations and do not necessarily represent the views of all AB
portfolio-management teams. Views are subject to change over time.

 

--------------------------------------------------------------------------------

About the Authors

Gershon M. Distenfeld, CFA

Gershon M. Distenfeld, Senior Vice President, is Co-Head of Fixed Income,
Director of Credit and a member of the Operating Committee. As Co-Head of Fixed
Income, he is responsible for the management and strategic growth of AB’s
fixed-income business. As Director of Credit, Distenfeld oversees all of AB’s
credit-related strategies, including all global and regional investment-grade
and high-yield strategies, as well as their associated investment strategy,
activities and portfolio-management teams. In this capacity, he leads AB’s
internal Credit Research Review Committee, the primary investment policy and
decision-making committee for all credit-related portfolios the firm manages.
Distenfeld also co-manages AB’s multiple-award-winning High Income Fund, named
“Best Fund over 10 Years” by Lipper from 2012 to 2015, and the
multiple-award-winning Global High Yield and American Income portfolios,
flagship fixed-income funds on the firm’s Luxembourg-domiciled fund platform for
non-US investors. He joined AB in 1998 as a fixed-income business analyst, and
served as a high-yield trader (1999–2002) and high-yield portfolio manager
(2002–2006) before being named director of High Yield in 2006. 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

Will Smith, CFA

Will Smith is a Senior Vice President and Director of US High Yield Credit. He
is also a member of the High Income, Global High Yield, Limited Duration High
Income, Short Duration High Yield and European High Yield portfolio-management
teams. Smith designed and is one of the lead portfolio managers for AB’s
Multi-Sector Credit Strategy, which invests across investment-grade and
high-yield credit sectors globally. He leads the monthly High Yield
portfolio-construction meeting, and is a member of the Credit Research Review
Committee, which determines investment policy for the firm’s credit-related
portfolios. Smith has authored several papers and blogs on high-yield investing,
including one on the importance of using a probability-based framework to build
better portfolios. He joined AB in 2012, and spent 2014 in London as part of the
European High Yield portfolio-management team. Smith started his career with UBS
Investment Bank, working as an analyst with the Credit Risk team and then later
on the Fixed Income sales and trading desk. He holds a BA in economics from
Boston College and is a CFA charterholder. Location: New York

Robert Schwartz

Robert Schwartz, Senior Vice President and Portfolio Manager, joined AB in 2012
as a corporate research analyst, covering specialty finance, automotive,
aerospace/defense and industrial companies. He analyzed the same industries as a
senior credit analyst at Citadel Investment Group and Bell Point Capital
Management. Schwartz started his career in Detroit as an automotive engineer,
where he was awarded two patents.

AB's emphasis on differentiated research and its long-term focus drew Schwartz
to the firm. Using automated tools—like the digitization of fundamental
research—that convert research into trade ideas is key to this active management
approach. “We focus on the range of possible outcomes,” he says. “We don't put
weight on a single point forecast or on trailing metrics.”

Schwartz's motivations are twofold: curiosity about how businesses perform
during various economic and industry cycles, and competitiveness to generate the
best returns for clients. “It's not a sprint,” he says. “It's a lot of sprints.”

--------------------------------------------------------------------------------


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