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As the rise in 10-year Treasury yields starts to impact equities, high-yield bonds remain a good investment, says Nicholas Leach, vice-president of global fixed income at CIBC Asset Management.

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The yield on U.S. 10-year Treasury bonds rose above 2.85% last week for the first time since January 2014, and equities had their worst week in two years after a red-hot start to the year.

So, it seems equities are being tested by rising bond yields, with some experts worried about the Treasury yield increasing borrowing costs for corporate bonds and putting pressure on stock valuations.

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Leach, who manages the Renaissance High-Yield Bond Fund, said the yield on Treasurys shouldn’t have a huge impact on the total return in the high-yield market. In fact, over the longer term, the high-yield market has had a slightly negative correlation with the Treasury market, he says.

“We continue to believe that high yield is a great place for fixed income investors, especially in a rising-rate environment, because of that negative correlation with the broader bond market,” he says.

Read: Premiums for U.S. bonds set to rise: report

As central banks have tightened monetary policy and yields on government bonds have risen, Leach adds, “high yield has outperformed and we expect it to continue.” After bottoming out in September, Leach notes the 10-year Treasury yield moved from 2% to its current high (it was at 2.6% at the time of this interview in mid-January).

“That’s quite a big move. The total return on the 10-year Treasury [from September until the start of this year] was negative 4%,” Leach says.

The total return in the broader U.S. bond market was negative 1.2% over that period, and negative 0.1% for U.S. investment grade corporate bonds, he says. Meanwhile, high yield has had a total positive return of 1.7%.

Over the last 30 years, Leach says the high-yield market has had a negative correlation of 8% with the 10-year Treasury, and a 62% correlation with the S&P 500.

Read: Where to watch U.S. corporates

That relationship has proven correct in recent months, too, he says, as equities have reached all-time highs, corporate profits have improved, and unemployment has plummeted.

“All of this tends to be good for high-yield companies because it’s good for credit quality,” Leach says.

As the quality of credit improves, credit spreads tend to tighten, and “that provides a large cushion against the rising rates that we’re seeing in the Treasury market.”

Leach’s forecast for total returns in the high-yield market in 2018 is 6.3%. That compares to his 2017 call for 6.5%, which he made in January 2017, and the actual 2017 yield of 7.5%.

When forecasting, he finds “current yield is the best predictor of the future 12-month return for the high-yield market.”

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This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.

Originally published on Advisor.ca
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