One should learn to sail in all waters
– Italian proverb
There are more than a few investors these days that feel the frustration of what seems to be a somewhat “toppy” stock market, historically low bond yields and the prospects of an eventual rise in interest rates. Fixed income investors feel particularly stymied. If rates remain at or near current lows, traditional bond yields will continue to pinch income, and if rates rise these bonds will likely fall in value. A significant risk for not much income. What to do?
Lower rated, higher yielding securities in a properly managed account can offer a practical solution. First, they have significantly less interest rate sensitivity than their higher-rated cousins. So if rates do rise, the price impact should be less onerous. Secondly, historically low defaults and the skills of a good fund manager help to manage your risk. By now, the price impact of lower oil prices on the prices of high-yield bond funds has already been realized. Lastly, this asset class lends itself particularly well to a mildly active managed approach that can help avoid drawdown when the market trend turns down. As the chart below shows, high-yield bonds offer more than double the yield and 40% less interest rate sensitivity than the average corporate bond portfolio.
When the next major market correction does come, we should see deterioration of both stock and bond prices, especially if it is associated with a rise in rates. But unlike last time, the Federal Reserve won’t be there with the same depth of monetary policy tools to soften the blow. This fact alone should give pause to the acceptability of a buy and hold approach in today’s environment. Active management, the brunt of ridicule by proponents of low-fee indexing, is in season. Unless you don’t need the income, and don’t mind getting caught in an extended drawdown, you should look into a properly managed high-yield approach. Learning how to sail the current sea of uncertainty and low rates will help to keep your investment portfolio above water and on course.