Stocks have surged since their April lows, with demand especially high for higher-risk equities and technology stocks—including those issued by firms with unproven profitability. But economic growth is slowing, and trade-related uncertainty has yet to be resolved. For investors looking to rebalance portfolios or dial down portfolio risk, we believe high-yield bonds could be a compelling complement to equities.
High Yield: A Potential Path to Lower Overall Volatility
Equities have been on an undeniable hot streak. The tech-heavy NASDAQ has surged by more than 20% over the past year, fueled in part by enthusiasm about artificial intelligence (AI). With its potential to shore up productivity and rein in costs, the possibilities of AI seem endless. But while corporate AI adoption rates are on the rise, the extent to which firms can turn AI’s promise into profits is unclear. In our view, some equity valuations may be stretched.
Investors looking to remain in stocks but rotate out of higher-risk holdings typically look to rebalance into investment-grade bonds. Government bonds and high-quality credit assets do have their place in a diversified portfolio, but we believe high-yield corporate bonds warrant a closer look—particularly in today’s market.
Within the context of fixed income, high-yield bonds aren’t typically associated with lower risk. But as a complement to equities in an overall asset allocation, high-yield bonds can reduce portfolio volatility. Here’s how.
Over extended periods, high yield has historically generated equity-like returns with significantly less risk. Since 2000, the Bloomberg US Corporate High Yield Index posted an average annual return of 7.6%, with an average annual volatility of 7.1%. During this same period, the S&P 500 gained on average 9.8% but with a volatility of 13.8%—about twice that of high yield (Display, left). This dynamic is especially powerful in challenging markets when, historically, high yield has captured just 44% of equity drawdowns (Display, right).
