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Halloween is my favorite holiday. I love the spooky season and the eerie vibes that come with it. This is the time of year I can appreciate a good jump scare from a haunted house or scary movie. However, I don't like jump scares or surprises when it comes to investing. I try to limit any surprises by doing thorough research and understanding potential outcomes.
Nonetheless, there is always an element of uncertainty and risk in this business. Ideally, investments would be able to gain limitless returns without any risk, but unfortunately, that is not possible. In an effort to find the best combination of upside potential and downside protection, investors could look to bonds. The bond market’s repricing may offer investors the potential for equity-like returns as the ICE BofA US High Yield Bond Index yield is very close to the average return of the stock market.
Today's Chart of the Week shows the current yield to worst of the ICE BofA US High Yield Bond Index is 9.47%, while the average yearly return of the S&P 500 Index is 10.53%. Earning a 10% return in the stock market has generally been considered good; therefore, being able to earn a similar yield from a less risky bond sounds even better. This dynamic allows bond investors to have the potential to access returns that are highly competitive to the historical returns of equities. Although bonds are considered less risky, we do not want to ignore deteriorating fundamentals and blindly chase yields. Halloween may be over, but there are still debt-ridden zombie companies lurking around that may be one poor quarter performance away from insolvency. Now that the cost of capital is much greater, these highly leveraged companies may struggle to survive, while companies that are self-funding and flush with cash should fare better. In this higher rate environment, it is possible to find both — a credit that has good fundamentals and still has the potential to pay an attractive yield.
Key Takeaway
Investors are now able to get equity-like returns in the bond market. The decline in bond prices has created an opportunity for investors to lock in higher yields. This more attractive risk-to-reward ratio for higher-yielding bonds versus equities is hard to argue against. Investors should still want to avoid being spooked by zombie companies in search of these higher yields. These zombies will haunt investors with increasing interest expenses and limited growth as they struggle to service their debt to survive. Higher quality, high-yield bonds with strong fundamentals are the “sweet spot” where an investor can potentially attain equity-like returns while trying to reduce downside risk.
Definitions:
The ICE BofA US High Yield Bond Index tracks the performance of below investment-grade corporate debt publicly issued in the US domestic market.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
Opinions and statements of financial market trends that are based on current market conditions constitute judgment of the author and are subject to change without notice. The information and opinions contained in this material are derived from sources deemed to be reliable but should not be assumed to be accurate or complete. Statements that reflect projections or expectations of future financial or economic performance of the markets may be considered forward-looking statements. Actual results may differ significantly. Any forecasts contained in this material are based on various estimates and assumptions, and there can be no assurance that such estimates or assumptions will prove accurate.
Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. All information referenced in preparation of this material has been obtained from sources believed to be reliable, but accuracy and completeness are not guaranteed. There is no representation or warranty as to the accuracy of the information and Penn Mutual Asset Management shall have no liability for decisions based upon such information.
High-Yield bonds are subject to greater fluctuations in value and risk of loss of income and principal. Investing in higher yielding, lower rated corporate bonds have a greater risk of price fluctuations and loss of principal and income than U.S. Treasury bonds and bills. Government securities offer a higher degree of safety and are guaranteed as to the timely payment of principal and interest if held to maturity.
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