High Yield Bonds in Your Portfolio ?

High Yield bonds have proven to be an attractive addition to portfolios. They are not for the faint of heart however since they can be subject to large down years far in excess of those for investment grade. In fact, they have near zero correlation to Treasury bonds--not surprising since Treasury bonds benefit and high yield bonds take big losses during periods of extreme financial market uncertainty and the "flight to quality".

Their risk measures fall somewhere between stocks and treasury bonds and they have a relatively high correlation to US stocks. Nonetheless they show some attractive risk/return characteristics.

Ten Year data these include the worst year for high yield bonds in the last 20 years--2007 when high yield bonds fell 31%.

10 year returns Bond ETFs Hyg high yield gold vcit intermediate corporate green AGG aggregate US Bond (blue) VGIT Intermediate Corporate (Black)

There is considerable reversion to the mean in spreads (differentials) between high yield and investment grade bond yields with periods of financial crisis leading to the flight to safety and sharp widening of yields--as can be seen in the extreme move during the 2007-2008 financial crisis. Current spreads are low reflecting confidence in the US economy and low perception of financial risk.

 Investors looking to add high yield to their portfolios might consider a lower duration high yield bond ETF like SJNK which reduces duration risk=sensitivity to changes in interest rates. As can be seen below (SJNK short term high yield in green HYG intermediate term high yield in blue) during the last 2 years of rising rates short term has outperformed.