Why High Yield Belongs in Your Investment-Grade Income Portfolio

Many investors limit their mandates to credits rated BBB or higher. But they could tap high-quality high yield—without adding to overall risk.

A traditional investment-grade multi-sector bond portfolio offers clear attractions: low default risk combined with a modest yield pick-up over Treasuries in a readily understood package. Even so, this approach comes with an opportunity cost. An investment-grade-only portfolio misses out on the benefit of wider diversification, which creates the opportunity to manage risk more efficiently and potentially achieve higher income and better risk-adjusted returns.

For example, a simple 50/50 passive “barbell” combination of US Treasuries with high-quality (rated BB or B) US high-yield bonds has historically produced better outcomes than both BBB-rated US corporate bonds and the broader US Aggregate Index across a range of metrics. These include higher income, lower volatility, less interest-rate risk (duration), and higher risk-adjusted returns (Display)—features that have characterized the barbell approach over time.

Historically, Barbell Approach Has Generated Better Characteristics

Combining Negatively Correlated Assets

A credit barbell combines interest-rate-sensitive bonds with higher-yielding credit assets because their returns are usually negatively correlated. When riskier, growth-oriented credit assets such as high-yield bonds fall in value, government bonds and other interest-rate-sensitive assets usually rise, and vice versa. Because negatively correlated assets tend to take turns outperforming each other, investors can sell the outperformers on one side (for instance, high-quality high yield) and buy the cheaper bonds on the other (for example, Treasuries). That approach has historically tended to increase returns over time.

In our 50/50 barbell example, we used US Treasuries to represent interest-rate risk and US high yield as a proxy for credit risk. The investment-grade portfolio underperformed this barbell because it lacked enough exposure to credit risk to generate higher income and returns. Credit risk is typically well compensated with income. Using option-adjusted spread divided by volatility as a measure of income per unit of risk, we can see that US high yield is a very efficient income generator (Display).

High Yield Generates Most Income per Unit of Risk