28 Feb 2020

Time to reduce your High Yield

Reducing high yield bond risk

In the hunt for yield, many investors have been increasing their allocation to High Yield (HY) bonds. However, higher carry comes with higher risk – and many are now exploring safer ways to invest in High Yield. We examine here two strategies for lowering the risk profile of a HY bond allocation.

In High Yield, shorter duration does not always mean lower risk 

While many investors choose to mitigate default risk by investing in short-duration HY bonds, Chart 1 shows that a higher level of credit risk seems embedded here. Using the credit spread to see the risk premium attached to different HY bond maturities, we see a higher level of credit risk for short duration compared to longer duration.

Chart 1: In High Yield, shorter duration does not always come with lower risk

Historical credit spread for US High Yield bonds (in bps)


Source: Bloomberg Barclays, Lyxor International Asset Management. Data as at 31/01/2020.
Past performance is not a reliable indicator of future returns

Table 1 below shows that duration for the 1-3Y and 0-5Y indices are significantly lower than those of the All maturity and ESG indices. Higher duration tends to magnify the impact of a spread widening.

We will assess the effects of duration and spread widening in periods of market stress on this set of indices later in this report. 

Table 1: Index facts


*The first score is computed by giving a score of 0 to the non-rated portion while the second score is the one of the rated portion
Source: Bloomberg Barclays, Lyxor International Asset Management. Data as at 31/01/2020

In Table 2 below, we see that applying an ESG tilt into a High Yield bond portfolio (SRI index) or an ultra-low duration constraint (1-3Y) can significantly lower the risk profile of a high yield bond portfolio (volatility, maximum drawdown). Table 2 also shows that the SRI Sustainable Index generates a similar absolute performance versus its parent index, and a higher performance versus short duration indices over the long term. 

Table 2: Performance profile of USD High Yield bond indices


 Source: Bloomberg Barclays, Lyxor International Asset Management. Data as at 31/01/2020.
 Past performance is not a reliable indicator of future returns

An ESG tilt with Bloomberg Barclays MSCI SRI Sustainable Indices

Bloomberg Barclays MSCI SRI sustainable indices include filters based on MSCI ESG Research in index rules:

  • Minimum MSCI ESG Ratings of BBB (Issuer non-rated by MSCI ESG are excluded)
  • Exclusions based on Controversial businesses (as defined by MSCI ESG)
  • Exclusions based on business, norms, and controversies (no “Red flags”)

ESG eligibility is checked at each monthly rebalancing on the Bloomberg Barclays MSCI SRI sustainable indices

The impact of Energy on US HY bonds – and how ESG could help 

The Energy sector remains one of the largest contributors to overall defaults in US High Yield bonds, and according to Moody’s estimates will continue to do so in 2020.

Taking ESG factors into account could be a good way of reducing exposure to future risks which could lead to default.

Chart 2 shows that the ESG tilt in a High Yield bond exposure allowed for a reduced exposure to the US energy sector over the past five years. The average weight of the Energy sector has been between 11% (on the 1-3Y) and 13.5% (All maturity) on the non ESG exposures over the past five years. It has been only 7.8% in the High Yield ESG index over the same period.

Chart 2: 5Y historical weight of the Energy sector


Source: Lyxor International Asset Management, Bloomberg
Data as at 31/01/2020. Past performance is not a reliable indicator of future returns.

An ESG or an ultra-low duration tilt protects value during periods of market stress

We looked at the performance of US high-yield bond indices in the global market sell-off of Q4 2018 and the 2015 Oil Market sell-off. We found that HY ESG bond indices have proved more resilient over periods of market stress, sustaining lower spread levels and better risk profiles compared to other indices.

The performance of the High Yield bond index with an ESG or an ultra-low duration tilt has proven more resilient compared to indices with a 0-5Y duration or the all-maturities index over the two periods analysed. 

Table 3: Market stress performance analysis


 Source: Bloomberg Barclays, Lyxor International Asset Management. Data as at 31/01/2020.
 Past performance is not a reliable indicator of future returns

The lower exposure to the Energy sector of the ESG and the ultra-low duration indices has proved beneficial in comparison to the two other indices which hold a similar sector exposure.

Protect your High Yield bond allocation with Lyxor ETF

Climbing higher or reaching further takes proper preparation, especially if you’re unfamiliar with the terrain. Here we offer two unique ways to access the US high yield corporate bond markets via some less-travelled routes specifically designed to mitigate the risks they may come with. 

Risk Warning

 This document is for the exclusive use of investors acting on their own account and categorised either as “Eligible Counterparties” or “Professional Clients” within the meaning of Markets in Financial Instruments Directive 2014/65/EU. These products comply with the UCITS Directive (2009/65/EC). Société Générale and Lyxor International Asset Management (LIAM) recommend that investors read carefully the “investment risks” section of the product’s documentation (prospectus and KIID). The prospectus and KIID are available free of charge on www.lyxoretf.com, and upon request to client-services-etf@lyxor.com.

Except for the United-Kingdom, where this communication is issued in the UK by Lyxor Asset Management UK LLP, which is authorized and regulated by the Financial Conduct Authority in the UK under Registration Number 435658, this communication is issued by Lyxor International Asset Management (LIAM), a French management company authorized by the Autorité des marchés financiers and placed under the regulations of the UCITS (2014/91/EU) and AIFM (2011/61/EU) Directives. Société Générale is a French credit institution (bank) authorised by the Autorité de contrôle prudentiel et de résolution (the French Prudential Control Authority).

The products mentioned are the object of market-making contracts, the purpose of which is to ensure the liquidity of the products on the London Stock Exchange, assuming normal market conditions and normally functioning computer systems. Units of a specific UCITS ETF managed by an asset manager and purchased on the secondary market cannot usually be sold directly back to the asset manager itself. Investors must buy and sell units on a secondary market with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current net asset value when buying units and may receive less than the current net asset value when selling them. Updated composition of the product’s investment portfolio is available on www.lyxoretf.com. In addition, the indicative net asset value is published on the Reuters and Bloomberg pages of the product, and might also be mentioned on the websites of the stock exchanges where the product is listed.

Prior to investing in the product, investors should seek independent financial, tax, accounting and legal advice. It is each investor’s responsibility to ascertain that it is authorised to subscribe, or invest into this product. This document is of a commercial nature and not of a regulatory nature. This material is of a commercial nature and not a regulatory nature. This document does not constitute an offer, or an invitation to make an offer, from Société Générale, Lyxor Asset Management (together with its affiliates, Lyxor AM) or any of their respective subsidiaries to purchase or sell the product referred to herein.

Research disclaimer

Lyxor International Asset Management (“LIAM”) or its employees may have or maintain business relationships with companies covered in its research reports. As a result, investors should be aware that LIAM and its employees may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Please see appendix at the end of this report for the analyst(s) certification(s), important disclosures and disclaimers. Alternatively, visit our global research disclosure website www.lyxoretf.com/compliance.

Conflicts of interest

This research contains the views, opinions and recommendations of Lyxor International Asset Management (“LIAM”) Cross Asset and ETF research analysts and/or strategists. To the extent that this research contains trade ideas based on macro views of economic market conditions or relative value, it may differ from the fundamental Cross Asset and ETF Research opinions and recommendations contained in Cross Asset and ETF Research sector or company research reports and from the views and opinions of other departments of LIAM and its affiliates. Lyxor Cross Asset and ETF research analysts and/or strategists routinely consult with LIAM sales and portfolio management personnel regarding market information including, but not limited to, pricing, spread levels and trading activity of ETFs tracking equity, fixed income and commodity indices. Trading desks may trade, or have traded, as principal on the basis of the research analyst(s) views and reports. Lyxor has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. In addition, research analysts receive compensation based, in part, on the quality and accuracy of their analysis, client feedback, competitive factors and LIAM’s total revenues including revenues from management fees and investment advisory fees and distribution fees.