High yield: Shrugging off rising rates

Written by: Global Thought Leadership | June 02, 2017

Source: Bloomberg, as of 5/31/17.  Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The Bottom Line

  • High yield bonds (i.e., below-investment-grade) tend to behave very differently than “core” sectors of the bond market—an important consideration during periods of rising interest rates.
  • As shown above, the Bloomberg Barclays U.S. Corporate High Yield Bond Index produced positive results during 9 of the past 10 periods when the benchmark 10-year U.S. Treasury yield rose by more than 100 basis points.
  • In contrast, the Bloomberg Barclays U.S. Aggregate Bond Index—composed of investment-grade Treasuries, government-agency, corporates and securitized (mortgage-backed, asset-backed, commercial mortgage-backed) securities—had negative returns during these periods.
  • Looking specifically at the Federal Reserve tightening cycle last decade—a two year period of gradual rate increases that occurred between June 2004 and June 2006—high yield also notably outperformed with a cumulative total return of +16.18% compared with +5.94% for the aggregate index.
  • Investors may find the comparison with the 2004-2006 tightening cycle particularly relevant given that the current cycle is expected to play out gradually, barring unforeseen changes in the economic environment.
  • Why has high yield fared well when interest rates increased? Primarily because of the higher income—or coupon payment—they offer, which lowers duration or interest rate sensitivity.
  • That’s because the higher the coupon, the greater contribution it will likely make to duration—which is the weighted average of all the present values for a bond’s cash flows (both coupon payments and the final payment of principal)—relative to the final principal payment, which (because it comes at the end) has the most interest rate risk.
  • Higher yield and lower duration are an attractive combination in today’s environment, given investors’ ongoing interest in attractive income that can stand up to future rate changes.
  • Of course, high yield also exposes investors to greater default risk and price volatility, which makes individual security selection—and therefore active management—critical to success.


Sources: Bloomberg and Legg Mason


IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

Outperformance does not imply positive results.

Active management does not ensure gains or protect against market declines.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

High yield bonds are subject to increased risk of default and greater volatility due to the lower credit quality of the issues.

Asset-backed, mortgage-backed or mortgage related securities are subject to additional risks such as prepayment and extension risks.