With rates at historic lows and compressed credit spreads at the forefront of concerns for many investors, short-dated high yield bond strategies can be an attractive way to supplement income while limiting interest rate risk. interest and part of the credit risk found in traditional high rates. -performance funds. Although definitions may vary, these strategies focus on high yield bonds with a maturity of one to five years (these represent about 30-40% of the larger universe) or duration (a measure of interest rate sensitivity) from zero to three years. This group of funds represents a fairly small subset of the Morningstar High Yield Bond category (roughly 25 separate offerings).
In September 2021, the short-term strategy subset in the high yield bond category was offering an average SEC yield of 2.7%. Although lower than the SEC’s average yield of the broader category of 3.4%, it was still significant compared to the average yield of 1.2% for the intermediate core bond category. In this low yield environment, these strategies can offer an attractive yield increase while providing insulation against rising rates. But as with all funds, it’s important to look under the hood to fully understand the risks.
Given their shorter durations, this subset of high yield bond strategies generally outperform the larger category during interest rate spikes. When rates rose in the first 10 months of 2018, the typical short-term, high-yielding supply returned 2.0%, beating the median return of its larger category by 0.4%. More recently, when rates soared in the first quarter of 2021, short-term offers posted a typical return of 1.7%, 75 basis points better than the group’s norm.
Short-lived high yield funds also generally take less credit risk than traditional high yield strategies. In June 2021, the typical short-term, high-yield offering held 5 percentage points more of BB-rated debt, which is the highest rating for high-yield debt, than the standard for the high-yield category. . The typical short duration high yield fund also held 15 percentage points less in debt rated B and below. than the median of the high yield category. This posture usually results in less severe losses during difficult credit times. When high-yield debt faltered in the fourth quarter of 2018, the typical supply focused on short-term junk debt slid 175 basis points lower than the broader category. More recently, when the coronavirus rocked the markets in 2020 between February 20 and March 23, the median drop in the short-term high-yielding peer group was 16.9%, while the category norm at high yield was 21.0%.
Here are two short-lived high yield strategies that stand out for their in-depth approach to selecting large credits and resources.
Shenkman Capital Short Duration High Income (SCFIX), which has a Morningstar Analyst Rating of Bronze, represents a solid choice in this space. Shenkman Capital focuses exclusively on leveraged finance and has a strong team. Five long-time co-managers manage this strategy with the support of over 20 credit analysts, six traders and a six-person risk management team. The team uses a rigorous credit assessment process and shifts the strategy towards less leveraged and more liquid securities. From its inception in November 2012 until August 2021, the strategy’s conservative stance left its 3.5% annualized return behind the broader high yield category and even most short-lived high yield peers. . However, its risk-adjusted return, as measured by the Sharpe ratio, ranked among the better of the two peer groups over the same period, given its more moderate losses in more difficult markets. .
PGIM Short Term High Yield Income Rated Silver (HYSZX) is another strong option. The strategy is implemented by five high yielding US focused managers and approximately 30 leveraged financial analysts. The strategy uses a rigorous methodology, including a well-defined system for sizing issuer exposures. Management maintains its duration at less than three years, its average maturity at less than five years and the debt rated CCC at less than 10%. The strategy has delivered strong performance over time: From its launch in November 2012 through August 2021, its 4.9% annualized return has outperformed all of its separate short-term and high-return peers. While that performance was lower than the larger category over the same time frame, its Sharpe ratio landed in the top quartile of the category.
Overall, short-term high yield strategies offer a less volatile way to increase yield while limiting exposure to rising rates. That said, while these offers are generally more conservative than most high yield funds, investors should always look under the hood when choosing one, as some may carry additional risk. Things to watch out for include small research teams, concentrated portfolios, the heavy use of derivatives to reduce duration, and high stakes in lower-rated credits or smaller, less liquid transactions.