We recently allocated a significant portion (10% to 15%) of our our mutual fund portfolios to high-yield bond funds. We funded this allocation with a shift from stock funds. Here are 6 reasons we like high-yield bonds:

  1. We expect high yield bonds to generate returns over the next five years that are as good as or better than stocks with less short-term risk.
  2. Yields on high yield bonds are unusually high. Yields reached their highest level ever (23%) in late 2008, creating a compelling return opportunity even in extremely negative scenarios.
  3. We see potential for total returns into the teens over the next several years.
  4. High-yield offers better downside protection relative to stocks. High-yield will likely lag stocks during strong up days in the market, but we expect high-yield to hold up much better than stocks during a market downturn.
  5. We stress-tested our model by projecting high five-year default rates and still like the return potential. We feel that high default rates are more than priced in to current opportunities.
  6. High-yield bonds are often referred to as a risky or speculative asset class. The fact is, high-yield bonds have a senior claim over equities in the capital structure.

Our exposure to high-yield is through a combination of active managers who have been successful generating long-term returns above the benchmark. Crisis in the credit markets has created an opportunity to take advantage of the dislocations in high-yield bonds. Our approach to this asset class is to hire proven mutual fund managers who can best identify these opportunities.