Positioning high yield as an equity proxy

Further to our recent narrative regarding the shift from equity into high yield heading into volatility, a correction, bear market and/or recession, below are two more charts that illustrate the benefits of using high yield as an equity proxy to mitigate some of the downside risk.

Chart 1 – Drawdown from previous high

In the last 3 recessions (1990, 2001 and 2008) and bear markets (1990, 2000-2003, and 2008-2009) you can see that it was only in 1990 that high yield suffered the same drawdown as equities measured on a month-end basis. However, the drawdown (again on a month-end basis) was fairly moderate as far as bear markets are concerned. (NOTE: as the data is as of month end it doesn’t reflect the full drawdown of the equity market) As far as they go, 1990 was softer than 2000-2003 or 2008-9. During the bear markets of 2000- 2003 and 2008-9 high yield suffered less downside than equities and recovered to its prior high years ahead of equities.

This is a line chart showing the drawdown in percentage terms for the S&P 500 Index overlaid with the same drawdown for the Bloomberg Barclays US Corporate High Yield Total Return Index on a monthly basis from January 1987 through to April 2019 on a monthly basis. There are three areas of focus on the chart highlighting recessionary time periods: 1990, 2001-2003 and 2008-2009. In these time periods, it was only in 1990 that high yield suffered the same drawdown as equities  measured on a month-end basis. In the other time periods, high yield suffered less downside than equities and recovered to its prior high years ahead of equities.

Chart 2 – Gain off 12-month low

High Yield showed similar or less downside to equities in a recessionary bear market, but what about the upside? Coming out of the recessions/bear markets of 1990, 2001, and 2008 high yield enjoyed similar or better upside than equities.

We believe if investors are starting to be concerned about the potential for a recession and bear market (within the next 24 months) they may consider a shift of part of their equity weight into high yield. Should the historical relationship hold true, this will provide investors with better downside protection without sacrificing the upside. In fact, the trade into high yield removes any requirement of attempting to “perfectly time” a shift back into equities.

We tend not to think of high yield as a defensive position within one’s portfolio. However, history would show that relative to equities, high yield bonds have historically captured less downside with similar upside in times of extreme volatility. Investors may sacrifice some of the “last gains” of the equity markets but, to use the words of John Addeo, Manulife Investment Management’s CIO Global Fixed Income, we characterize this as “picking up pennies in front of a steamroller”.

This is a line chart showing the gain off 12-month lows in percentage terms for the S&P 500 Index overlaid with the same for the Bloomberg Barclays US Corporate High Yield Total Return Index on a monthly basis from January 1987 through to April 2019 on a monthly basis. Similarly with the previous chart, there are three areas of focus highlighting recessionary time periods: 1990, 2001-2003 and 2008-2009. In the months following these recessionary periods, high yield bonds recorded similar or better upside relative to equities. We believe if investors are starting to be concerned about the potential for a recession and bear market within the next 24 months, they may consider a shift of their equity allocation into high yield bonds. Should the historical relationship hold true, this will provide investors with better downside protection without sacrificing too much upside.

A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates. 

Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.

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Philip Petursson
Philip Petursson, 

Chief Investment Strategist, Manulife Investment Management

Manulife Investment Management

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Kevin Headland
Kevin Headland, 

Senior Investment Strategist, Manulife Investment Management

Manulife Investment Management

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Macan Nia
Macan Nia, 

Senior Investment Strategist, Manulife Investment Management

Manulife Investment Management

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