High yield funds, also known as junk bonds, can provide investors with higher yields compared to investment grade fixed income securities. However, these funds also carry higher risk due to the lower credit quality of the underlying bonds. When analyzing the performance and suitability of high yield funds, it is important to consider factors like historical returns across market cycles, risk-adjusted returns, fees, fund manager experience, and portfolio composition and credit quality. This article reviews several high yield funds across these metrics to determine relative performance and help guide investment decisions.
High yield fund returns are cyclical and vary across market environments
The contents provided highlight that high yield fund returns tend to be cyclical, with significant spread widening and higher defaults during recessions, which leads to negative or low returns. For example, in 2008 during the global financial crisis, the BofA Merrill Lynch US High Yield Index returned -26%. However, in more normal or expansionary markets, high yield funds can provide returns in the mid to high single digits. For instance, the index returned 18% in 2009 as credit spreads contracted significantly off crisis highs. When analyzing historical returns, it is important to consider performance across different market cycles and macro environments.
Risk-adjusted returns should be evaluated using metrics like Sharpe and Sortino ratios
While high yield funds may provide higher absolute returns than investment grade bond funds, they also take on greater risk which must be accounted for. Using metrics like the Sharpe ratio and Sortino ratio, which measure return per unit of total and downside risk respectively, allows for an apples-to-apples comparison of risk-adjusted returns across funds. Funds with higher risk-adjusted return ratios have historically provided better returns for the level of risk assumed. However, these measures have limitations when applied to high yield funds given the non-normal return distribution, so they should be considered as only one factor in the evaluation process.
Fund costs and manager experience should be reviewed closely
The materials discuss how high yield funds can have management fees over 1%, which are higher than more traditional bond funds. While the higher fees may be justified by active security selection and credit research, they still directly impact net returns to investors. Comparing fees across similar funds can help identify potential options that provide better value. Additionally, reviewing the experience and track record of the high yield management team is prudent, as unique expertise in analyzing troubled companies and securities can be a differentiator in generating strong risk-adjusted returns over time.
Understanding portfolio credit quality and diversification is key
When reviewing a high yield fund’s holdings and characteristics, investors should pay close attention to the credit quality, sector exposures, and number of positions held. High yield fund returns are driven in large part by credit fundamentals, so funds tilted towards higher quality BB-rated bonds may underperform in rallies but provide downside protection in downturns. Significant exposure to distressed bonds rated CCC and below adds risk. Diversification across sectors and a broad number of issuers helps mitigate idiosyncratic default risk. A well-constructed portfolio appropriate for an investor’s risk objective and market outlook can contribute to superior high yield fund performance.
Evaluating high yield funds requires a multi-faceted approach considering returns across market cycles, risk-adjusted return metrics, fees, manager skill, and detailed portfolio construction. This allows investors to select high yield funds aligned with their investment goals and risk tolerance.