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.

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