Nordic High Yield: For which investors does it make sense?
Let's take a look at what high-yield bonds are, what makes them risky, and why investors should consider incorporating them into their portfolios.
In general, high yield bonds, commonly known as junk bonds, inherently possesses some interesting attributes as an investment class.
The obvious pros and cons
The number one advantage is income. Expected returns for high yield bonds is considerably higher than for investment grade bonds, but the risk, measured as the volatility of return, is also higher.
Expected risk and return from high yield investments on the other hand is lower than for equities. Moreover, the returns from high yield investments will typically be positively correlated with equity returns.
These characteristics naturally raises questions about the attractiveness and for what types of investors the asset class might be suitable.
Investing will always be a tradeoff between risk and return.
High yield has quite consistently been found to have attractive risk-adjusted returns
Unfortunately, the history of data for the Nordic high yield market doesn’t so far allow for meaningful, detailed analysis of risk-adjusted returns compared to other relevant investment opportunities. However, analyses of risk-adjusted returns for global or US high yield relatively consistently show that the risk-adjusted return from investments in high yield compares favorably with equities.
Below is a table adapted from Ilmanen (2011) which shows one measure of the risk-adjusted returns for various rating categories in the US high yield market and for global and US equities, respectively. The measure used here is the Sharpe ratio which measures the return per unit of risk (standard deviation of return).
The main driver behind the result that high yield offers attractive risk-adjusted returns is that risk (or volatility) in high yield is considerably lower than for equities.
