From Anomaly to Opportunity: High Yields on Short Bonds

27 March 2023

6 min read

Will Smith, CFA| Director—US High Yield

Robert Schwartz| Portfolio Manager—High Yield

Gershon M. Distenfeld, CFA | Director—Income Strategies

Stock and bond markets were shaken by the recent banking crisis in the US and Europe. Although both US and European authorities took prompt action to prevent damage to the financial system and dampen market volatility, these episodes highlight the importance of risk management and the worth of proven investment strategies that can both mitigate risk and generate worthwhile returns.

Historically, higher-rated short-duration high-yield bonds have provided strong returns with defensive characteristics. Now, with yield curves inverted across North America, Europe and parts of Asia, investors no longer need to increase interest-rate risk (duration) to earn extra income.

Shorter Bonds Make for Lower Risk

Short-dated high-yield bonds are intrinsically less risky than longer-dated counterparts, as their shorter maturities leave them less exposed to both default- and interest-rate risk. Further, as these bonds currently trade below par (Display), their prices will likely rise as they approach maturity, generating capital gains.

Short Duration High Yield at One of the Most Attractive Points in Last 20 Years

Bloomberg Global High Yield Corporate 1-5 Year Index: Starting Annual Price and Yield

These bond prices were lowest in the 2009 Global Financial Crisis (GFC), but 2023 is their second lowest-priced year in 20.

Historical and current analyses do not guarantee future results.
Price and yield for market represented by the Bloomberg Global High Yield Corporate 1-5 Year Index.
As of February 28, 2023
Source: Bloomberg and AB

What’s more, by concentrating on the higher-quality segment of short-dated high yield, investors can create more defensive portfolios for a relatively small reduction in yield (Display).

High-Quality Short-Dated High-Yield Bonds Have Offered Attractive Yields

Average Yields in US Dollars Over Different Timescales (Percent)

Over one, three, five and ten-year periods these bonds have yielded about 1% less than the global high-yield market.

Current and historical analyses do not guarantee future results.
Indices used are Bloomberg Global High Yield Corporate Index, hedged to US dollars, and US 10-Year Treasury Bond Yield.
As of February 28, 2023
Source: Bloomberg and AB

Over the 20 years ending September 30, 2022, BB- and B-rated high-yield bonds between one and five years to maturity captured more than 80% of the broader high-yield market return, while experiencing approximately 50% of the average monthly drawdown. Consequently, they have provided better risk-adjusted returns than their longer-dated (five- to ten-year) high-yield counterparts. But they have really come into their own during periods of extreme market stress. At these times, higher-quality, short-duration high yield has exhibited much lower downside capture than both the global and US high-yield markets (Display).

Higher-Quality Short-Duration High Yield Captured Less Downside When Spreads Widened

Cumulative Return When US High-Yield Spreads Widened 50 Basis Points or More (Percent)

In major crises including the GFC these bonds’ prices fell significantly less sharply than US and global high-yield markets.

Past performance does not guarantee future results.
Periods when US high-yield spreads widened 50 b.p. or more. US corporate high-yield returns and spreads are represented by Bloomberg US Corporate High Yield Index; global high-yield hedged returns are represented by Bloomberg Global High Yield Corporate hedged to USD Index; and higher-quality short-duration high-yield returns are represented by Bloomberg Global High Yield Ba/B 1–5 Year Index hedged USD.
As of February 28, 2023
Source: Bloomberg and AB

In our analysis, dynamically managed short-duration high-yield strategies that can allocate tactically to higher-rated assets, including investment-grade bonds, may achieve even more consistent performance. By varying the allocations to return-seeking and more defensive bonds as market conditions change, investors may have the opportunity both to capture higher returns in risk-on periods and to guard against downside risks in choppier markets.

Inverted Yield Curve Favors Shorter Bonds

Currently, owing to inverted yield curves, investors have a potentially highly attractive entry point for investing in short-duration high-yield bonds, as high-yield bonds with five or fewer years to maturity offer significantly higher yields than longer-dated counterparts (Display).

Shorter-Duration High-Yield Bonds Offer Higher Yields than Their Longer Counterparts

One- to two- year bonds yielded 1.7% more than 10+ year bonds as of February 28, 2023.

For illustrative purposes only. Current and historical analyses do not guarantee future results.
As of February 28, 2023
Source: Bloomberg Global High Yield Corporate Index and AB

In an uncertain world, we think shorter-dated, higher-rated, high-yield strategies could be particularly well-suited to delivering attractive risk-adjusted returns.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

About the Authors

Will Smith, CFA

Will Smith is a Senior Vice President and Director of US High Yield Credit. He is also a member of the High Income, Global High Yield, Limited Duration High Income, Short Duration High Yield and European High Yield portfolio-management teams. Smith designed and is one of the lead portfolio managers for AB’s Multi-Sector Credit Strategy, which invests across investment-grade and high-yield credit sectors globally. He leads the monthly High Yield portfolio-construction meeting, and is a member of the Credit Research Review Committee, which determines investment policy for the firm’s credit-related portfolios. Smith has authored several papers and blogs on high-yield investing, including one on the importance of using a probability-based framework to build better portfolios. He joined AB in 2012, and spent 2014 in London as part of the European High Yield portfolio-management team. Smith started his career with UBS Investment Bank, working as an analyst with the Credit Risk team and then later on the Fixed Income sales and trading desk. He holds a BA in economics from Boston College and is a CFA charterholder. Location: Nashville

Robert Schwartz

Robert Schwartz is a Senior Vice President and Portfolio Manager for High Yield. Previously, he was an AB Corporate Credit Research analyst, covering specialty finance, automotive, aerospace/defense and industrial companies. Prior to joining the firm in 2012, Schwartz analyzed the same industries as a senior credit analyst at Citadel Investment Group and Bell Point Capital Management. Before beginning his investing career in 2005, he was a project leader with Boston Consulting Group, where he advised industrial and financial companies on corporate strategy. Schwartz started his career as an automotive engineer working in Detroit, where he was awarded two patents. He holds a BS in mechanical engineering (summa cum laude) from the University of Michigan and an MBA (with high distinction) from the University of Michigan’s Stephen M. Ross School of Business. Location: Nashville

Gershon M. Distenfeld, CFA

Gershon Distenfeld is a Senior Vice President, Director of Income Strategies and a member of the firm’s Operating Committee. He is responsible for the portfolio management and strategic growth of AB’s income platform with almost $60B in assets under management. This includes the multiple-award-winning Global High Yield and American Income portfolios, flagship fixed-income funds on the firm’s Luxembourg-domiciled fund platform for non-US investors. Distenfeld also oversees AB’s public leveraged finance business. He joined AB in 1998 as a fixed-income business analyst and served in the following roles: high-yield trader (1999–2002), high-yield portfolio manager (2002–2006), director of High Yield (2006–2015), director of Credit (2015–2018) and co-head of Fixed Income (2018–2023). Distenfeld began his career as an operations analyst supporting Emerging Markets Debt at Lehman Brothers. He holds a BS in finance from the Sy Syms School of Business at Yeshiva University and is a CFA charterholder. Location: Nashville

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