Looking at where we were just a year ago, we have seen a notable move upward in US Treasury yields, with the 2-year yield going from 1.29% at the at the end of April 2017 and nearly doubling to the current level of 2.49%, while the 10-year was at 2.35% a year ago and has now surpassed the 3% level.1
Of note, most of the move in the longer end of the curve, the 5-yr and 10-yr, has come in just the past six months. These rate moves have left many questioning just what that means for fixed income investors, especially those in the high yield corporate bond world.
If we look to history, that should give us some comfort as we face the potential of higher rates. In the over 30 years of data, since 1986, Treasury yields have increased (i.e., interest rates rose), in 15 of those calendar years. In all but one of those 15 years, high yield has outperformed the investment grade bond market. The long-term numbers show that over those 15 years when we have seen Treasury yields/interest rates increases, high yield had an average annual return of 12.4% (or 9.2% if you exclude the massive performance in 2009). This compares to only a 4.4% average annual return (or 3.4% excluding 2009) for investment grade bonds over the same period.2
So the data is clear that the high yield bond market has historically not only provided investors with solid returns during years in which we see interest rates increase, but has also dramatically out performed its investment grade counterpart.
Looking at this is a different way, below we lay out the historical returns for the high yield index during periods of rising rates. Here we specifically look at how the index performed prior to and following periods when rates rose 30bps, 50bps, 70bps, and 100bps over certain periods of time.3
So it isn’t just full year periods where we see positive returns, but this data demonstrates that we have also historically seen positive returns in the months during which interest rates are increasing and the months after those increases have occurred.
As we have noted in some of our recent writings, this historical performance does makes sense given the high yield bond market’s lower duration and the fact that high yield performance seems to be much more tied to credit quality and default rates. We generally see rates rising in the face of economic strength—which also happens to be the premise for the current argument for rates to go higher—and economic strength generally leads to stable and/or low default rates, benefiting high yield bonds.
For more on how the high yield market has historically performed during periods of rising rates and various investment strategies in the face of potentially higher rates, see our recent piece “Strategies for Investing in a Rising Rate Environment.”