Unlocking income potential in high yield bonds

Key points

• High yield bonds offer the potential for higher income in client portfolios, supported by benign default risks and relatively firm asset class fundamentals.
• In a portfolio context, high yield has historically delivered this income with lower interest rate sensitivity than other fixed income assets, and a degree of equity market upside with less volatility.
• The normalization of policy rates could increase the attractiveness of high yield bond income relative to cash yields.
• BlackRock offers high yield solutions to fit a wide range of client needs and preferences—spanning index, enhanced index, and fully active solutions.

High yield today – potentially attractive income and fundamentals

Recent economic performance has shown continued strength, with corporate profits and consumer spending remaining largely resilient in the face of high interest rates. This environment suggests a benign default cycle and supports the outlook for high yield credit where all-in yields appear historically attractive. Figure 1 shows how the level of yield in the high yield market, while down from its recent peak, remains elevated on a historical basis and compared to cash yields. Market expectations for the path of policy rates (dashed yellow line) illustrate how the relative attractiveness of high yield bonds could continue to increase with interest rate cuts.

High yield investing intuitively comes with a higher degree of risk relative to cash and other fixed income assets, and relatively tight spreads make managing default risks more important to forward returns. However, the quality composition of the high yield market has notably improved over recent decades, implying a more resilient pool of issuers. Roughly 50% of the asset class today is BB rated (the highest quality rating in high yield), and the percentage of CCC rated bonds is 11% versus 20% in 2007.¹ Interest coverage ratios, balance sheets, and profit margins also point to a broadly firm fundamental backdrop.

Beneath the surface, the smaller portion of companies on the low end of the high yield rating spectrum have shown some divergence from broader market trends of tight, low volatility spreads. This has led to elevated spread dispersion in the high yield sector, which could persist in a high interest rate environment that challenges fundamentally weaker companies. This is one example of where enhanced and active strategies could potentially provide an investment edge through credit selection and avoiding the most default-prone issuers while successfully identifying those with potentially attractive valuations relative to those risks.

Where do high yield bonds fit in client portfolios?

Portfolio allocations to high yield can be considered relative to both equity and fixed income exposures. High yield has historically offered a degree of equity upside return potential with lower volatility and less downside risk. Compared to fixed income, high yield has provided enhanced income and return potential with less sensitivity to interest rates (Figure 2).

Figure 2: High yield characteristics versus other fixed income exposures

These characteristics allow high yield bonds to play a range of different roles in portfolios—whether to potentially enhance yield when sourced from investment grade or core bonds, or to maintain upside potential while diversifying risk asset exposures like equities.

BlackRock’s suite of high yield bond strategies

BlackRock offers a spectrum of high yield strategies to fit client preferences and constraints. These include market index exposures (USHY), enhanced index strategies (HYDB), and fully active strategies (BYHIX and BRHY).

Market index exposure with USHY

Clients can gain exposure to high yield market beta through our diverse range of high yield index funds, for example the iShares Broad USD High Yield Corporate Bond ETF (USHY) which offers low cost (0.08%), transparent, and efficient broad high yield market access. 

Having launched in 2017, USHY is the industry’s largest high yield ETF today, and has a track record of consistently delivering performance in line with the full high yield market since launch. Since inception in October of 2017 through 7/31/24, USHY has an annualized return of 4.08% vs. 4.16% for the ICE BofA US High Yield Constrained Index, a tracking difference below that of its average fee over that time.²

Additionally, our expansive suite of index solutions includes ETFs with a strong history of liquidity for tactical usage, targeted duration and credit exposures—offering the opportunity to employ active decision-making with a robust toolkit of more targeted high yield index bond ETFs.

Enhanced index exposure with HYDB

The iShares High Yield Systematic Bond ETF (HYDB) offers clients higher risk-adjusted return potential—maintaining upside capture while mitigating the downside of the high yield market all at a low cost relative to fully active peers. HYDB can be considered a “step out of index,” applying a rules-based approach to screen out the riskiest bonds in the high yield universe while identifying those with the most attractive relative valuations. The goal is to maintain upside participation while limiting downside in the asset class by maximizing income and attractively valued exposures while limiting and systematically managing exposure to the riskiest issuers.

Over the strategy’s nearly seven-year history, this approach has allowed HYDB to deliver higher absolute and risk-adjusted returns than the Bloomberg US Corporate High Yield Index with average annual outperformance equaling 0.74% since inception. It has achieved this result through capturing greater market upside while generating more resiliency in down markets than the average high yield strategy.³

Active exposure with BHYIX and BRHY

Clients can also target outperformance in high yield with the BlackRock High Yield Bond Fund (BHYIX) and BlackRock High Yield ETF (BRHY) which employ a fully active approach leveraging the full breadth of BlackRock’s industry-leading credit and risk management resources. These “all-weather” strategies seek to maximize income and return potential using a variety of levers. BHYIX and BRHY have the ability to increase and decrease exposures versus the benchmark based on the team’s level of conviction and take advantage of relative value opportunities through tactical intra-capital structure positioning and through interrelated asset classes.

BHYIX and BRHY aim to remain agile and are centered around dynamically managing between risk-on and risk-off positioning as market conditions evolve rather than being painted with one brush. Our investment philosophy is rooted in rigorous fundamental credit analysis, with over 95% research coverage of the high yield universe. ⁴

Since inception in 1998, the BHYIX institutional share class has delivered excess annualized returns net-of-fees of 0.34% over the Bloomberg US High Yield 2% Issuer Capped Index.⁵ The fund has been able to achieve this result through a variety of market environments over the past 26 years by delivering higher upside capture and lower downside capture than the peer group. In fact, BHYIX is in the top 3rd percentile of its peer group (Morningstar US Open-End High Yield Bond Category) over the 15 year period, and is ranked 8th out of 279 funds on a total return basis. ⁶

Clients seeking to outperform broad high yield markets may also want to consider a combined allocation to our enhanced and active strategies. While both HYDB and BHYIX have delivered strong performance individually, Figure 4 illustrates their unique return profiles across different high yield market return environments. With this in mind, a 50/50 combination of the two strategies has generated positive returns across each regime with only a 0.15 monthly active return correlation since HYDB’s inception.⁷

Conclusion

Attractive all-in yields and fundamental strength remain supportive of the opportunity set in high yield credit. In the context of portfolios, high yield can enhance portfolio income relative to other fixed income assets, while providing a degree of equity upside with less volatility. BlackRock’s high yield strategies offer a range of options to fit your clients’ needs. Consider leveraging our tools and resources on BlackRock’s Advisor Center, including the 360 Evaluator where you can test the impact of adding high yield allocations to portfolios.