High-Yield Bonds: Yields Are Up, But Risks Remain

Although high-yield bonds have performed well so far this year, we continue to take a cautious view.

High-yield bonds have been one of the best-performing bond investments so far in 2023, but we continue to suggest a neutral view on the asset class.

Coming into the year, we were cautious on high-yield bonds given the risks of rising rates and tighter financial conditions. Investors generally have shrugged off those risks, pulling high-yield spreads down and prices up.

As we look forward, we maintain our cautious stance, but acknowledge that the rising likelihood of a "soft landing" may keep high-yield bond prices supported. While we don't necessarily expect it to happen, a soft landing—where growth slows enough to cool inflation, but the economy avoids recession—could prevent corporate profits and revenues from falling.

More importantly, the starting level of yields generally makes it harder for high-yield bonds to post a loss for a full year even if prices rise. High-yield bonds tend to offer high income payments, which can help offset potential price declines. The Bloomberg US Corporate High-Yield Bond Index offers an average yield of roughly 8.5% which appears relatively attractive if investors plan to hold for a while and can ride out the ups and downs. Since 1990, there have been a total of 96 months during which the average yield of the index ended the month between 8% and 10%, and only 13 times has the index posted a negative return over the subsequent 12 months. A majority of those 12-month losses occurred during the 2008-2009 financial crisis, and all but four of the 13 negative returns were losses of 2.3% or less.

But we prefer investment-grade corporate bonds that have generally have A and BBB credit ratings1 and offer average yields that are close to 6% with much less credit risk than high-yield bonds.