Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 426

It's not high return/risk equities versus low return/risk bonds

A thorough understanding of how sub-investment grade bonds work, and the reasons for their high yield, can help investors discard the ‘junk’ label, and potentially replace it with ‘juicy’.

Interest rates might be predicted to rise in the US but for many months they have been kept notoriously low globally as governments use monetary policy to stimulate economies out of COVID-19 induced lulls. As a result, the return on investment grade bonds has also been low, and not much better than cash. But it is possible to generate equity-like returns from bonds, with a lower risk than previously thought.

What is junk?

Whether going by the name of speculative, junk or high-yield, any bond with a rating less than BBB is sub-investment grade. These bonds are given lower ratings because the issuer is deemed to be less likely to pay the bond back (in other words, they are more likely to default), therefore the investor is compensated for the increased risk with the higher return.

The US high-yield bond market accounts for $US1.5 trillion in issuance, with more than 1,000 issuers that include Netflix, Tesla, Ford American Airlines and MGM.

The Bloomberg Barclays Global Aggregate Bond Index includes almost all investment grade bonds and accounts for $US60 trillion in debt. Its average yield is around 1%. The smaller Global High Yield Index has a market value of $US2.3 trillion but an average yield of 5.8%. Despite its smaller size, this index generates $130 billion in annual income.

To put that in perspective, the global high-yield market is just 4% the size of the investment-grade market but generates 20% of the income.

Risk versus return

Of course, investing in high-yield bonds is not all smooth sailing, and when the aggregate index is broken down, a negative price return can be observed. That is because over time some of the bonds in the index do default or fall in price when investors start to get nervous about an issuer’s credit standing.

But there are enough bonds in the index – potentially hundreds - to compensate if any one company defaults. And even if a bond falls in value, the yield, or coupon, is fixed and the investor will continue to receive that income.

Since 1996, the US High Yield Index had an average return of 7.8% from coupons and -1.1% from price, resulting in a total return of 6.6%. Since 1986, the US High Yield Index has had an annualised total return of 8.2%. The S&P 500 returned an annualized 10.6% over the same period. Not bad for bonds! 

Bonds versus equity

The elephant in the room here, of course, is that while an annualised total return of 8.2% for high-yield bonds is attractive, it’s not as good as an annualised return of 10.6% which is what the S&P 500 has returned since 1986.

But we’re not arguing that high-yield bonds are a substitute for equities here. Rather, as a yield-producing investment, they can play a role in a portfolio alongside equities, traditional fixed income and other asset classes.

The income-producing features of high-yield bonds are also attractive to investors at certain life stages. Retirees, for example, are much more interested in income returns than capital returns and do not like volatility.

When comparing the standard deviations of the high-yield bond index and equities, high-yield bonds have far less volatility than equities but higher returns than other bond classes, as per the table below.

Another factor working in high-yield bonds’ favour is their lack of sensitivity to interest rate changes, compared to other bonds. Traditionally when interest rates rise, as is expected to happen in the US in the not-too-faraway future, bond prices fall as there is an inverse relationship between interest rates and bond prices.

However, high-yield bonds offer investors higher interest rates over and above official cash rates, and the differential between the cash rate and the bond’s higher coupon is likely to be a much bigger influence on high-yield bond prices.

Furthermore, cash rates usually increase during periods of economic growth, which are positive environments for high-yield bond issuers, as their creditworthiness improves.

A place for everything

It’s time to shake off the traditional idea of high-return, high-risk equities and low-risk, low-return bonds. Every asset class has value in its own right.

High-yield bonds carry more risk than investment grade bonds, but they also offer higher income returns, less volatility and less sensitivity to cash rate movements. All factors which make an allocation to high-yield bonds in an investment portfolio - alongside traditional equities and bond allocations – worth considering.

 

Damien McIntyre is CEO of GSFM, a sponsor of Firstlinks and distributor of the Payden Global Income Opportunities Fund in Australia and New Zealand. This article contains general information only. Please consider financial advice for your personal circumstances.

For more papers and articles from GSFM and partners, click here.

 

  •   22 September 2021
  • 2
  •      
  •   
2 Comments
Ramon Vasquez
September 23, 2021

Hello .

Does NBI . AX qualify as a Hi-yield Bond ?

Best wishes , Ramon .

Warren Bird
September 26, 2021

Good to see someone else championing this asset class, as I did 7 years ago here: https://www.firstlinks.com.au/invest-junk
I stress that you need to get over the inappropriate use of the word 'junk'. That's how this sector of the market started nearly 100 years ago, but these days it mostly just means either highly volatile or highly indebted, but solidly managed. There are household names who've operated as high yield companies for decades without skipping a beat. They might in the future - hence the rating below BBB (investment grade) - but not because they're bad companies.
I'd add that you HAVE to do this via a highly diversified managed fund if you want to obtain its benefits, otherwise you're tail risk could blow the strategy away completely if one or two individual high yield bonds default, as is quite possible.
Over the 7 years since I wrote the article, the high yield fund in which I've been personally invested has done exactly what I expected. Less than the stellar 10% plus that the share market has provided, but delivering a few % pa better than corporate bonds and similar to those multi-asset target return funds that you pay high fees for. And I remind readers that there are many 7-10 year periods where high yield outperforms shares.
As Damian says - worth considering. Talk to your adviser.

 

Leave a Comment:

RELATED ARTICLES

High yield downturn will be long and ugly

Why would you invest in junk?

The diversification illusion: why 'balanced' portfolios may be exposed

banner

Most viewed in recent weeks

2 billion reasons to fix retirement income

A proposal to address Australia's 'stranded balances' in retirement by requiring super funds to transition members to pension phase at 65, boosting retirement income and reframing super as a source of income.

The ultimate superannuation EOFY checklist 2026

Here is a checklist of 28 important issues you should address before June 30 to ensure your SMSF or other super fund is in order and that you are making the most of the strategies available.

Do super funds need a massive wake up call?

UK retirement expert, Guy Opperman, believes super funds are failing at supporting members in deaccumulation. Here is what Australia should do about it. 

Two months into retirement

A retirement researcher's take on retirement and her focus on each of her six resource buckets to stay engaged during the transition and beyond.

Reforming the taxation of wealth and wealth transfers

As the budget approaches debate continues about the need and method for addressing wealth inequality. Could reinstating wealth transfer taxes be the answer?

Welcome to Firstlinks Edition 662 with weekend update

The debate over the budget is increasingly shaped by frustration and perceptions of unfairness, rather than clear-eyed assessment of policy outcomes.

Latest Updates

Back to the future - Why indexing CGT is a good idea

A return to indexation of capital gains would be a fairer way to compensate households for the effects of inflation than the current discount. Importantly, it opens the door to future, broader reforms to stop the taxation of inflation.

Australia has no death duties. Technically.

Australia may not levy formal death duties, but a growing web of tax measures is quietly shaping what wealth passes between generations. Now, the 2026 budget adds another layer.

Strategy

The folly of the Iran war

From oil shocks to fractured alliances, the Iran war carries the hallmarks of a historic policy misstep - one that could tip an already fragile global economy into crisis.

Taxation

Noel Whittaker’s take on the budget

Marketed as a fix for inequality and housing affordability, the latest budget instead delivers a tangle of tax changes that leave everyday Australians worse off.

Investment strategies

The red metal's long game

Copper has had a rough few weeks but investors should not ignore the potential for future price increases as supply increasingly falls behind demand.

Taxation

The lesser-known effects of changed property taxes

The budget’s property tax reforms are being framed as fairness measures, but they risk splitting the housing market, penalising lower‑income investors and introducing distortions that may prove costly.

Latest from Morningstar

Why stocks sometimes fall for no obvious reason

The vast and opaque world of private assets is a powerful gravitational force - and when trouble hits, it's the more liquid public equities that often the feel it first.

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.