Chart of the Moment: Behind U.S. High Yield’s Impressive Resilience

Some compare high yield risk to equities while others liken it to core fixed income. A look at performance shows high yield often has a resilience and risk-adjusted return potential all its own.

Imagine it is the first day of 2022. I tell you that over the next two and a half years, through June 30, 2024, the Russell 2000 Index of small-capitalization U.S. stocks is going to decline -5.4% and the Bloomberg U.S. Aggregate Bond Index is going to decline -8.9% on a total return basis. Based on that knowledge, you now have to forecast the U.S. high yield market over the same time period as measured by the ICE BofA U.S. High Yield Index. What would your forecast have been? Probably not positive 3.4%, which was the actual result. Of course, we do not have the luxury of knowing in advance what other risk assets are going to return. However, high yield’s outperformance is striking, nonetheless. How could that be?

It was not due to the starting valuation, since the High Yield Index spread was 310 basis points, the yield-to-worst was 4.3%, and the dollar price was over 103 cents on the dollar. Two and a half years later those metrics were 321 basis points, 7.9%, and just under 93 cents on the dollar, respectively. Instead, the answer lies in the resilience of the high yield asset class due to its lower duration and higher stated interest rates than most of fixed income.

The duration of the High Yield Index was around 4 years at the beginning of 2022. The market repriced dramatically in the first half of 2022 as base interest rates increased materially and investors forecast a high probability of recession. On a total return basis over that 6-month period, the High Yield Index was down -14%, the Russell 2000 was down over -23%, and the U.S. Aggregate Bond Index was down over -10%. By the middle of 2022, the spread of the High Yield Index was close to 600 basis points, the yield-to-worst was close to 9%, and the dollar price was less than 86 cents on the dollar. For the two years from June 30, 2022, the High Yield Index was positive 20.2%, the Russell 2000 was positive 23.5%, and the Aggregate Index was positive 1.7%.

As is typically the case, the price of the high yield market adjusted rapidly to new information. The low duration then meant substantial cash—interest payments, calls, tenders, maturities—could be reinvested at the new, more attractive yields. The Russell 2000 fared better than the High Yield Index for the two years from June 30, 2022, but it was not enough to offset the larger drawdown in the first half of 2022. The Aggregate Index was slightly positive for that two-year time period through June 30, 2024, but suffered from lower interest payments and much higher starting duration. While the High Yield Index clearly benefited from a benign credit environment, the index’s resilience has been demonstrated in severe credit cycles as well.

In the opening weeks of the third quarter of 2024, the Russell 2000 has made up more than half of its underperformance compared to the High Yield Index. But the High Yield Index has also performed well as the increase in U.S. equity market value supports credit quality and access to capital in the high yield market. Some perceive high yield risk be to be equity-like, others more like core fixed income. We believe the reality, as we saw in this period, is that high yield is especially resilient, often generating compelling risk-adjusted returns compared to stocks or core fixed income over time.

Index Definitions

The Bloomberg U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

The ICE BofA U.S. High Yield Index tracks the performance of U.S. dollar-denominated below investment grade corporate debt publicly issued in the major domestic markets.

The Russell 2000^® Index, which is a subset of the Russell 3000® Index, measures the performance of the small-cap segment of the U.S. equity universe. It includes approximately 2,000 of the smallest securities based on a combination of market capitalization and current index membership.