The search for permanent income in uncertain times
By Tyler Gile, Portfolio Analyst
Short-dated, high-yield bonds and senior floating-rate loans offer diversified yield opportunities with limited interest-rate risk.
Investors have had a tumultuous start to 2022. In this climate, we believe that short-duration high yield and senior floating-rate loans represent an attractive option if you are looking for durable income with lower duration compared to other traditional fixed-income sectors.
Within high yield, short duration bonds currently yield about 85% of the market’s total return, but at less than half the duration. This revenue capture belongs to the top decile of observations over the past decade. A similar theme exists in lending, where the yield lock-in is about 80% compared to the high yield market, but given the variable interest rate on the loans, results in one of the highest yield ratios per unit term in the entire fixed income landscape.
Additionally, given their higher natural fluctuation and lower volatility, short maturities and loans can be a powerful tool for investors amidst changing economies. These assets generally repay or mature within three years, providing an efficient way to take advantage of market dislocations without increased transaction costs. Additionally, over the 10-year period ended 12/31/21, short duration and loans have shown approximately 75% of the realized volatility of other higher yielding asset classes. However, these asset classes have less convexity and therefore lower return potential than the broader high yield market, especially after sell-offs. Finally, looking at the broader fixed income universe, short duration and credit have historically maintained a low/negative correlation with Treasuries, thus providing an important source of diversification for investors, particularly in times of rising interest rates.
In terms of overall market health, we continue to see high yield and credit issuers stabilizing their margins and improving their balance sheets. In addition, the trajectory of real GDP growth and improved pricing power should continue to support fundamentals for most issuers. These factors have helped push default rates across both asset classes to all-time lows, and we believe they will remain well below historical averages for the foreseeable future.
This year has shown that investors need to optimize their duration allocation and we believe fixed income positioning will become increasingly important as we navigate a higher volatility environment. Short duration high yield bonds and senior adjustable rate loans offer an attractive option if you are looking for diversified total return opportunities with limited duration risk.
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice. This material is general in nature and is not intended for any category of investor and should not be construed as individualising, a recommendation, investment advice or as be considered a proposal to engage in or refrain from engaging in an investment-related approach. Investment decisions and the appropriateness of this material should be made based on an investor’s individual objectives and circumstances and in consultation with their advisers. The information has been obtained from sources believed to be reliable, but no representation or warranty is made as to its accuracy, completeness or reliability. All information is current at the time of publication of this material and is subject to change without notice. The company, its employees and consultant accounts can hold positions of all discussed companies. Any views or opinions expressed may not reflect those of the company as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all types of customers. This material may contain estimates, forecasts, projections and other “forward-looking statements”. Actual events or market behavior could differ materially from the views expressed as a result of a variety of factors.
An investment involves risk, including a possible loss of capital. Investing in hedge funds and private equity is speculative and carries more risk than more traditional investments. Investments in hedge funds and private equity are intended for experienced investors only. Indexes are unmanaged and not available for direct investment. Past performance is no guarantee of future results.
This material is distributed on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. Please visit www.nb.com/disclosure-global-communications for the specific entities and legal limitations and restrictions.
The Neuberger Berman name and logo are registered service marks of Neuberger Berman Group LLC.
© 2009-2022 Neuberger Berman Group LLC. All rights reserved.
Publisher’s Note: The summary points for this article were selected by Seeking Alpha editors.