Risk assets, be it high-yield bonds, equity markets worldwide, are not pricing in all that much bad news. The rates markets worldwide are. One of them is wrong.
I see time and time again that people say we’re later in the cycle, I don’t want to own higher-income assets. The problem with that is that history suggests that every time you have a sell-off in higher-yielding assets, equities do worse. Usually a lot worse.
We actually looked at every time high yield had a sell-off of five or more percent. That happens about once every two or three years. In every period in the past 25 years, equity sold off more. If we take a dollar out of the equity side of our portfolio and put it into income-generating assets, there we actually reduce the amount of risk we have in the portfolio.
It’s because high-yield debt is half as volatile as equity securities. And, you do keep most of the return. We looked at the yield of the market over the past 20 years, and we then looked at the next five years return at any point in time, and we saw a tremendously high correlation. Your starting yield is actually a really good representation of what to expect over the next five years.
I’ll give you some examples. When yields were at pretty high points back at the end of ‘02 and the end of ‘08—end of ‘02 was about 14 percent; end of 2008, about 20 percent. Your returns over the next five years from ‘02 to ‘07 were about 14 percent; your returns at an annualized basis from ‘08 to ‘13 was about 20 percent. And, it works when yields are low as well.
Over the past 30 or 40 years, equities beats high yield, no question about it. But it has almost double the risk.
So, think about it: In an environment where we have all of these concerns, instead of putting all my eggs in the equity basket, which can sell off a lot if things go in the wrong direction, go into income-generating assets. It’s a mind-set shift. Instead of increasing risk in the portfolio to generate income, I can reduce risk to generate income.
Gershon Distenfeld is Co-Head of Fixed Income and Director of Credit at AllianceBernstein.
The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams, and are subject to revision over time.