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With today’s extremely low interest rates many investors are considering purchasing high yield bonds, also known as junk bonds, as a way to maintain and/or improve the income they receive from their investments. Short background: high yield bonds are bonds issued by companies that have credit ratings of BBB- or lower by Standard & Poor’s or Baa3 or lower using Moody’s credit ratings.
These bonds are called high yield bonds because they pay interest rates that are higher than investment grade companies to compensate the investors for the risk they are taking by investing in a company that may not be as financially strong as other companies.
The question becomes: are investors receiving enough additional interest to offset additional risk?
To attempt to answer this question I put together the following table that compares the returns over the past 25 years of the Barclays US High Yield Corporate Bond Index with the Barclays US Aggregate Bond Index (this index almost entirely comprised of high quality bonds). All returns are for that year except for 2012 which is January 1 to September 30.
High Yield Index Aggregate Bond Index
1987 4.99 2.76
1988 12.53 7.89
1989 0.83 14.53
1990 -9.59 8.96
1991 46.18 16.00
1992 15.75 7.40
1993 17.12 9.75
1994 -1.03 -2.92
1995 19.17 18.47
1996 11.35 3.63
1997 12.76 9.65
1998 1.87 8.69
1999 2.39 -0.82
2000 -5.86 11.63
2001 5.28 8.44
2002 -1.41 10.25
2003 28.97 4.10
2004 11.13 4.34
2005 2.74 2.43
2006 11.85 4.33
2007 1.87 6.97
2008 -26.16 5.24
2009 58.21 5.93
2010 15.12 6.54
2011 4.98 7.84
2012 12.13 3.99
Average Annual Return 8.69% 7.12%
Ratio of positive years 81% 92%
Conclusion: Over the past twenty five years, the High Yield Bond Index experienced more down years and larger losses during those negative years than high quality bonds but rewarded investors with 22% greater average annual returns.
When you change the time frame, however, you also change the results.
Over the past 20 years, the High Yield Bond Index returned an average of 8.50% per year with three negative years vs. 6.46% average annual return for the Aggregate Bond Index with two negative years.
Over the past 10 years, the High Yield Bond Index returned an average of 9.37% per year with two negative years vs. 5.75% average annual return for the Aggregate Bond Index with no negative years.
Disclosures:
- The Barclays U.S. Aggregate Index is comprised of approximately 6,000 publicly traded bonds including U.S. government, mortgage backed, and corporate bonds and has an average maturity of approximately 10 years.
- The Barclays U.S. Corporate High Yield Index covers the universe of fixed-rate, noninvestment grade debt.
- It is not possible to invest directly in an index.
- All information was provided by Morningstar and although believed to be reliable, they do not guarantee the completeness or accuracy.
- This historical information represents past performance and should not be considered indicative of future results.
- Returns do not include effects of taxes, capital gains or transaction costs.
