4 benefits of high-yield assets

By Suzanne Sharma | October 17, 2013 | Last updated on October 17, 2013
3 min read

Fund managers should take advantage of high-yield assets.

So says Andrew Kronschnabel, portfolio manager at Logan Circle Partners in Philadelphia. He manages the Renaissance U.S. Dollar Corporate Bond Fund.

Read: Lots of promise in high-yield bonds

He adds there are four key benefits of doing so:

1. Enhanced returns. High-yield assets enhance the potential return profile of a fund, while only slightly adding to volatility, says Kronschnabel.

In fact, “a quick analysis of the 10-year analyzed returns of an 80/20 blend using Barclays index data [shows] the blended fund would’ve returned nearly 6.5%,” he adds. That compares to 5.5% annualized returns for a purely investment grade portfolio.”

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Further, “these markets, while they are very similar, do exhibit periods where they outperform or underperform one another. The volatility of the blend over the 10-year period was nearly the same as the investment grade-only mandate,” says Kronschnabel.

2. Improved yield profiles. Using the same comparison, Kronschnabel notes the above-mentioned fund yields 4.5%. The Barclays investment grade index currently yields about 3.25%, so there’s “roughly 125 basis points of additional yield with the inclusion of high-yield assets.”

3. More choice. The high-yield market has grown dramatically over the past decade, says Kronschnabel. It’s about $1.23 trillion in size and includes over 2,100 unique bond issuers.

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He finds, “By considering the investable opportunities in the high-yield market, it increases our efficient bond by more than 30% over just the high-grade market alone.”

4. Lower interest rate exposure. High-yield assets are less sensitive to changes in interest rates compared to investment grade assets, says Kronschnabel.

“The high-yield assets…shorten the overall fund by almost 10% relative to an investment grade-only fund, and I’d argue the effect is more dramatic in reality,” he adds.

Read: Choose shorter terms as rates rise

Investment tips

Investors interested in high-yield opportunities should look to the primary market.

That’s because “issuers [in that space] offer slight concessions to the existing outstanding bonds to successfully place and price large bond deals,” says Kronschnabel.

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The investment grade market, on the other hand, has seen more than $800 billion of new issuance this year.

The main problem is “not every new issue offers value,” he adds. “In fact, the pricing process for corporate bonds is imperfect—it’s not uncommon for new bonds to trade poorly [following]…issuance due to pricing that is too rich.”

Kronschnabel also finds the corporate fixed-income markets are arcane in terms of transaction and pricing conventions. “In contrast to the equity markets where there’s essentially one investable security, the fixed-income markets typically offer many bonds,” which makes it difficult for investors to choose,” he says.

Consider that while Ford Motor Company has one stock available for purchase, the company offers several options when it comes to investable bonds. They all have different characteristics and are available in different currencies. What’s more, there are several types of coupons to choose from, adds Kronschnabel.

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There’s also no effective electronic trading or pricing mechanisms on the fixed-income corporate market, says Kronschnabel, given that “the price at which securities are traded is negotiated between the buyer and seller, and traded over the counter.”

On the plus side, “[Though] this can be confusing for the individual investor, it creates rich opportunity in the secondary market…Institutional traders [can] select the best securities for the portfolio based on the unique risk and liquidity profiles of the individual bonds.”

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Suzanne Sharma