High-yield bonds over equity investments?

Volatility in equity investments has brought focus to other asset classes, and T. Rowe Price says that high-yield bonds are key to diversification in a long-term investment portfolio. High-yield credit has been able to deliver equity-like returns with less volatility, and investors are also taking advantage of the potential compounding effect of coupon payments.

The investment management firm talks about how high-yield bonds have low credit ratings, and carry higher risk, which is offset by higher yields for investors.

“High yield bonds are often considered to be a hybrid asset class because they tend to exhibit characteristics of both fixed income and equities,” writes Kevin Loome, Portfolio Manager at T. Rowe Price.

While fixed-income benefits exist, high-yield credit behaves like equities considering the credit risk and is thus linked to the performance and fundamentals of a business. This hybrid nature makes high-yield credit attractive to both equity and fixed-income investors.

“An analysis of historical sources of return shows that, unlike stocks, high-yield bonds have typically derived the majority of their long‑term total returns from income rather than capital appreciation,” says Loome, adding that relatively high and consistent coupon payments have helped the bonds to have low volatility than stocks.

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