Don’t Make the Mistake of Thinking High Yield Protects You on the Way Down

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We have noted that there seems to be a belief that that ‘high yield’ instruments hold up best in a weakening market.  I think this belief started back in 2008 and early 2009 when one could pick up higher yield preferreds and exchange traded debt, sometimes for 20-25 cents on the dollar and then hold them for the recovery. The only problem with this scenario is that one had to be in cash or have a lot of cash when the crash happened so that they could take advantage of the unfounded panic. If you were a long term holder, as most of us try to be, and held the high yield instruments all you did was ride a very fast sled down and then wait for recovery.

If the economy and the stock market are sensing tough times ahead NOW, regardless of interest rates, one would be wise to move their holdings higher on the quality spectrum. Sure you give up some coupon, but given the performance of high yield this year you would be way ahead in total.

Below is a chart of 2 ETF’s. HYG represents ‘high yield’ bonds while AGG represents investment grade bonds. Obviously HYG represents many of the energy issues, shippers, and MLP debt and we know what has happened to high yield preferreds in these sectors. From 2007 HYG is now down 20%, while AGG is up 10%—a 30% spread. High yield was great if you bought only at the bottom (and who honestly was smart enough to go to cash prior to the crash and then brave enough to buy low quality at the bottom?).  We were mostly cash and did buy some at the bottom–but not boatloads–we wish were that brave.

There really is not a reason for a long term holder to leave high yield if they have the fortitude to hold them through thick and thin.  In fact if you are willing to stay on the ‘ride’ you can theoretically do better with hgh yield.  It is mostly not for us though, but certainly a lot we hold may fit a definition of high yield–but we will weed them out the minute we see trouble in any issuer in which we have a position. We mainly are driven by strength in a given sector which is why we have avoided most MLPs and upstream energy. 

With the above in mind we will be trying to go through quarterly reports of many of the issues we hold in model portfolios as well as in our personal holdings to make sure we don’t get surprised by many of the issues we hold.

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Bryan Perry Dividend Income Expert Bryan Perry

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