When underlying yields go up, prices go down? Not in high yield!

When underlying yields go up, prices go down? Not in high yield!

Underlying government bond yields are moving consistently higher as the outlook for growth and inflation continues to surprise to the upside. Year-to-date returns for global investment grade are -3.28% versus +0.67% for global high yield.  

 

So what is the reason for the differential in credit returns? Quite simply, it’s the composition of the underlying yield from risk-free and credit spread. Within investment grade, 54% of the yield is from spread (92bps of spread against 1.71% yield) in comparison to high yield where 87% of the yield is from spread (375bps of spread against 4.31% yield).

 

This makes the asset class far less sensitive to underlying risk-free rate moves, which logically makes sense. As a lower-rated cohort of companies within fixed income, high yield corporate spreads are more tied to economic recoveries than investment grade, which is more tied to the move in underlying rates (the two should in theory be inversely correlated). As a result, high yield tends to do well in a rising rate environment with its lower duration characteristics and its corporate spreads tied to economic fundamentals.

 

In short, high yield is a quasi-asset class that sits somewhere between traditional fixed income and equities. It straddles the dynamics of both markets which has resulted in the asset class achieving equity like returns, but with around half the historical volatility.

USD-HY-OAS.jpg

Source: Bloomberg Barclays, Goldman Sachs Global Investment Research

Mark Benbow

Investment Manager, Fixed Income

Mark Benbow is an investment manager in the Fixed Income team. 

More about the author


Read next