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?

Are these assets the missing piece in Australian portfolios?

banner

Most viewed in recent weeks

Does your will qualify for the discretionary testamentary trust exemption?

Treasury has confirmed the exemption many families were hoping for. But buried in the fine print are two conditions that could leave some wills on the wrong side of the exemption, despite years of careful planning.

Are you making these SMSF mistakes?

After four decades advising investors, there are a few common mistakes I've seen SMSF investors make. From holding too much cash and chasing yield to overtrading and trusting tips. Are these errors costing you?

Lithium's latest drop and what it means for ASX investors

Lithium's latest sell-off has punished ASX miners as prices remain hostage to shifting expectations. The key challenge is navigating a market prone to extreme volatility despite a strong case for the long-term demand outlook.

Retirement spending is not one-size-fits-all

New data challenges the idea that Australians are underspending their super. The bigger issue may be helping retirees navigate complexity, make confident decisions and use their savings to support security, wellbeing and choice.

Why have Australian living standards 'fallen' and how do we fix it?

For the last few years there has been much talk of a 'cost-of-living' crisis in Australia and of 'falling living standards'. Lately this has flared up again with the pickup in inflation resulting in a renewed fall in real wages.

The missing link in the CGT debate

A little-noticed consequence of Labor’s tax changes could have implications well beyond investors’ tax bills. The issue raises bigger questions about incentives, capital allocation and the drivers of long-term economic growth.

Latest Updates

Planning

Testamentary trusts have secured the CGT exemption

Treasury’s latest CGT reform draft delivers a win for testamentary trusts and deceased estates, exempting estate-derived gains from the 30% floor. However, questions on death and divorce rollovers remain unresolved.

Superannuation

How much super should you have?

Average super balances are one of the most misleading benchmarks. They ignore your goals, spending and future needs, creating a false sense of security. Here is how I calculate exactly where I need to be at every decade.

Retirement

Retiring from work is easy, retiring into life is harder

Most people spend decades planning how to retire. Far fewer plan for what comes next. The biggest retirement challenge isn't always financial, and it often catches even the most prepared retirees completely off guard.

Shares

Right asset class, wrong index: the trap in Australian small caps

Most Australian portfolios are concentrated in large caps, with relatively little exposure to smaller companies. But what if the biggest risk isn't the economy, interest rates or valuations? For many, the risk is hidden in plain sight.

Property

Are these assets the missing piece in Australian portfolios?

Many investors remain concentrated in shares, cash and property. Despite their popularity among institutional investors, real assets remain underrepresented in many SMSF portfolios. Could they be the missing piece?

Investment strategies

The biggest risk that buy-and-hold investors ignore

Investors spend decades learning how to stay invested, yet few have a plan for getting out. When a financial goal has a hard deadline, a worked example shows why a fixed derisking schedule should outrank buy-and-hold discipline.

Investment strategies

How passive investing is driving the decline of active fund alpha

Why have active managers struggled as passive investing has surged? Research suggests that flows into index funds and ETFs are creating structural headwinds, penalising the stock-picking strategies that once generated alpha.

Sponsors

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 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.