Bonds: High Yield

(New York)

One of the most underappreciated areas of the bond market is in mortgage-backed securities. Anyone familiar with the Financial Crisis will instantly know why. However, the asset class itself offers many attractive advantages compared to other bonds. There are three main points of appeal: higher yields, liquidity, and low correlation to risk assets. MBS ETFs average 2.79% yields (much higher than Treasuries), have much greater liquidity than corporate bonds, and have the lowest correlation to risk assets of any fixed income instrument.

FINSUM: If you can get of the trauma that the acronym caused, MBS can be a very good asset class for many different market environments.

(New York)

One of the big questions in this market fall is why junk bonds aren’t tumbling in tandem with stocks. Generally speaking, high yield bonds trade in the same direction as small cap stocks as they are driven more by company fundamentals than other areas of the bond market. However, in the recent rout, this was not the case, as junk bonds have continued to perform well. When both markets fall in unison, it usually means there is big trouble brewing, but when they have become uncorrelated, it can mean there is a rally to come. For instance, in 2011, small caps fells strongly, but junk only a touch. In the following months, small caps surged 15%.

FINSUM: We think this is a positive sign for small caps, as high yield investors are not worried about company fundamentals.

(New York)

By now one would have expected junk bonds to have experienced a large selloff. The sector already had a low spread to Treasuries, has mountains of fringe credits, and has been facing a period of rising rates. Yet, high yield has been performing very well, with the weakest credits, paradoxically, performing best. There has been no sustained flight out of the sector, and spreads are higher than at the start of the month, but still not even where they were for much of the year.

FINSUM: The big risk here is that investors aren’t being paid enough for the risks they are taking. The whole junk sector, not to mention the loads of BBB credits that are technically investment grade, are very susceptible to recession and higher rates. At some point there are going to be some major losses.

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