“Aren’t you limiting your investment universe?”
“Don’t shorter dated bonds have less yield?”
It’s common for questions like this to be asked when you’re talking about the short dated high yield asset class. And yes, it’s undeniable that both can be true, but it’s also my belief that within a diversified portfolio there’s merit in including this asset class.
When looking for a return, the profile and composition is better known the closer you are to the bond’s maturity. The nature of a bond, and its final maturity, means that investors know exactly how much money they will make between the start date and the date that the bond matures. The uncertainty lies in how much of that return is achieved from one year to the next – and in my experience it’s rarely a straight line.
I’m only able to estimate the return profile, rather than giving an exact figure, but this assessment is helped by the knowledge that bonds are issued at par (cash price of 100) and redeemed at par, (the exception being if a company defaults before maturity).
And, as with the rest of the high yield team here, I target higher quality companies with recurring cash flows – where the company will continue to exist well beyond the life of the bond. For instance, we currently choose not to hold any CCC-rated credit within the short dated high yield fund. And the result of this choice is that we are able to reduce potential default risk and rely on the ‘pull to par’ effect of the bonds.
The chart below highlights the total returns of the Global High Yield 1 to 5 Year Index. As you can see, while the short dated high yield market may not always generate a positive return from one month to the next, history shows that over any 5 year rolling period (using any start date over the last 20 years) the asset class has generated a positive return almost 100% of the time.
Source: Bloomberg: ICE Bank of America Merrill Lynch.