5 March 2020
There is a case for including high yield in fixed income portfolios. Doing so can both boost the stability of returns and reduce volatility as an asset largely uncorrelated to government bonds.
As a risk asset, a rebound in the economic data should be supportive but, as long as growth remains positive, we would expect high yield to remain relatively stable versus government bonds. Issuance and default risks look contained with the main risk being a recession in the eurozone.
The traditional appeal of bonds is that they can provide income when economic conditions are strong and a safe haven when the backdrop turns sour (benefitting from price appreciation). However, the combination of negative ECB rates coupled with asset purchases and low inflation has left many European government bonds with negative yields. With yield curves back close to their flattest levels since 2008, additional returns from extending out along the curve and taking extra duration risk are low.
The alternative route to enhancing yield has been to add credit risk. There were substantial flows into credit funds during 2019. According to State Street Global Markets data, in Q4 2019 there were heavy inflows into the EUR corporate universe (see the Q1 2020 SPDR Bond Compass for full analysis and commentary).
However, investors now look heavily overweight, according to this flow data. With investment grade (IG) credit spreads having compressed to government bonds, the option-adjusted spread on the Bloomberg Barclays Euro Corporate Bond Index has narrowed from over 160bp in early 2019 to below 100bp. Those seeking yields will need to continue the journey out along the credit spectrum.
To learn more on the role of high yield in the current market environment, please read our latest note, The Case for High Yield.
Navigating Fixed Income ETFs
The growth of ETFs has made the task of navigating the investment landscape more challenging. To guide investors, we have created a practical framework to help select the fixed income ETFs that best meet their needs, whether they’re seeking risk, yield or diversification.
For investors who would like to learn more, please read our Framework for Selecting Fixed Income ETFs .