CHICAGO – A lively discussion on high-yield bonds sounded to my ears like a commercial for the product, and I was not persuaded.
In a session titled “High-Yield Bonds at a Crossroads” at the Morningstar Investment Conference, three high-yield experts discussed the state of the market and the role high-yield bond funds should play in a diversified portfolio.
Listening to the arguments, I feared that high-yield bonds sounded like a free lunch – with not nearly enough discussion of the perils.
I didn't hear the word "junk" mentioned once during the session, which is another name for below investment grade debt. As I see it, take your client's risk with equities and have the fixed-income portfolio in high-quality, low-cost bond funds. The role of fixed income should be that of a portfolio stabilizer with the goal of only keeping up with inflation. My advice to clients is don't buy expensive junk no matter how attractive the yield may look. Why? Because there is no free lunch.
In an environment of record low nominal interest rates, session moderator Sumit Desai of Morningstar noted the attractiveness of a 7.5% yield. To his credit, he did at least note the high-correlation of high-yield debt to equities.
Fidelity's Fred Hoff claimed that owning high yield should give a long-run return equal to the 7.5% yield; I can't believe he didn't mention the impact of defaults. T. Rowe Price's Mark Vaselkiv endorsed the magic of compound interest while also leaving out the agony of bankruptcy.
Desai showed a chart of a loss of 15.65% over the past year for high-yield energy. To that, Wellington's Michael Hong said he was bullish on the sector.
Eight years past the financial crises, Desai asked whether last year was a hiccup for high yield or the beginning of the next downturn. The panelists pointed to no systemic issues. There was some mention of illiquidity, but no mention of the Third Avenue fund that denied redemptions last year due to the illiquidity of the underlying holdings.