Why dividend investors should consider high yield debt too
Author: Andy Kochar
April 18, 2019
One of the biggest challenges facing investors in volatile times like today is figuring out a way to cushion their exposure to riskier assets without sacrificing too much in potential return. For many, that often translates into strategies that emphasize value over growth, defensives over cyclicals and, more generally, larger allocations to dividend-paying stocks.
Often overlooked in this regard, however, is the important role that high yield corporate bonds can play over a full market cycle – especially one accentuated by periodic ups and downs.
For example, the Bloomberg Barclays US Corporate High Yield Total Return Index has delivered competitive annualized returns versus the S&P 500 Dividend Aristocrats Total Return Index and other global dividend benchmarks such as the TSX Dividend Total Return Index over the past decade and a half.
| Annualized returns, as of Dec 31, 2018 | 1-year return | 3-year return | 5-year return | 7-year return | 10-year return | Since common inception |
|---|---|---|---|---|---|---|
| BBgBarc High Yield Corporate TR USD | -2.10% | 7.20% | 3.80% | 6.00% | 11.10% | 7.00% |
| S&P 500 Dividend Aristocrats TR USD | -2.70% | 9.80% | 9.10% | 13.30% | 14.60% | 10.00% |
| S&P/TSX Composite Dividend TR CAD | -8.60% | 7.40% | 4.90% | 6.60% | 8.30% | 5.50% |
Source: Morningstar, December 2018, common inception December 16, 2005.
Better yet, the key high yield index has provided higher risk-adjusted returns (as shown by its Sharpe Ratio) than both of these two dividend indexes.
| As of Dec 31, 2018 | Sharpe Ratio 5 Yr | Sharpe Ratio 10 Yr | Sharpe Ratio 15 Yr |
|---|---|---|---|
| BBgBarc High Yield Corporate TR USD | 0.63 | 1.36 | 0.65 |
| S&P 500 Dividend Aristocrats TR USD | 0.81 | 1.07 | 0.72 |
| S&P/TSX Composite Dividend TR CAD | 0.52 | 0.75 | - |
Source: Morningstar, December 2018
One of the advantages that high yield has had over dividend-paying stocks over this stretch is a more attractive average yield profile. But high yield also has the added benefit of maturing, an important factor in mitigating risk during bouts of heightened volatility.
Dividend paying equities may carry a stable yield but have a continual value based on a stream of perpetual cash flows that may get discounted higher or lower through time, resulting in much higher volatility.
High yield issues, by comparison, have a duration of three years on average, which implies that only six coupon payments are to be discounted back with a fixed maturity date. Combined with much higher compounded carry, this makes for a healthier way to generate alpha during times of elevated volatility.
To be clear, high yield bonds cannot match dividend-paying equities in achieving outright returns. But in periods of heightened volatility, they offer excellent performance with much better downside protection. As such, equity investors who include high yield in their portfolio are left with a more efficient mix of holdings that can offer the highest expected return for the right level of risk.
Andy Kochar is a Portfolio Manager and Head of Credit at AGF Investments Inc. He is a regular contributor to AGF Perspectives.
About AGF Management Limited
Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.
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© 2019 AGF Management Limited. All rights reserved.
Written by
Andy Kochar, CFA
Portfolio Manager and Head of Credit
AGF Investments Inc.
