The short-term US high yield bond market could potentially offer higher returns and comparable volatility to investment grade bonds, according to Karen Chen, senior product specialist, Allianz Global Investors.
For the past three years, high yield (or sub-investment grade) bonds outperformed investment grade bonds despite the enthusiasm among strategists for the latter. Their average shorter duration as well as higher yields gave them the edge.
“Over history, high yield bonds had delivered equity-like returns, rather than perform like investment grade bonds because they are less sensitive to changes in interest rates,” said Chen (pictured), pointing out that the consensus now is for just one interest rate cut by the US Federal Reserve this year.
The yield of US sub-investment grade bonds (those with credit ratings below BBB-) with maturities of 0-5 years was 7.66% with a duration of 2.59 years at the end of 2024.
“Short duration high yield bonds offer the greatest yield relative to duration,” said Chen, emphasising that the high yield market successfully navigated covid, the energy crisis and interest rate hikes.
In fact, the high yield bond market has developed significantly from its early days as a niche allocation for wealthy individuals eager to lock in high absolute yields at the expense of illiquidity and credit defaults.
The market’s size has grown to more than $1.3trn today from around $300bn in 2000, and its quality has also improved during the past 15 years. Its average credit rating is BB, while single-B issues make up 40% of the market; in 2000 only 30-35% was designated BB by the credit agencies, data collected by Allianz Global Investors shows.
Moreover, the market is more diverse, with issuers from energy companies comprising about 11%, healthcare 10% and financials 9%. The default rate is also low at about 1.5% compared with an historical average rate of about 3.5%.
Active strategies
Some asset managers, such as Allianz Global Investors, have identified these trends and have been quick to offer individuals an opportunity to participate in the market through fund strategies.
“Active management of short duration high yield bonds delivers a core alternative for fixed income investors,” said Chen.
The flagship $3bn Allianz US Short Duration High Income strategy* has generated a cumulative return of 50.74% since its inception in December 2015 to 28 February 2025.
During the past three years to 28 February 2025, it has returned 18.58% with volatility of only 5.20% and a high information ratio of 0.84.
The strategy is part of the firm’s established income and growth platform, and co-managers Jim Dudnick and Steven Gish are solely dedicated to this strategy.
“The strategy’s objective is to offer capital preservation and long-term income with lower volatility,” said Chen.
The portfolio’s sector allocations range from communications and support services to gas distribution and healthcare. The average credit rating is B+, and the yield to worst is 8.24% and duration to worst is 2.52 years.
During the period of interest rate hikes in 2022, the strategy not only outperformed the broad high yield market, but it also delivered better performance than investment grade corporate bonds. This makes the strategy a good complement to a core fixed income allocation.
It currently has a diversified portfolio of around 110 holdings. The coupon mix is 7-8%, compared with about 4% before 2022. The strategy does not own subordinated bank debt.
“The strategy is focused on the short-end of the high yield market where there are better risk-returns than in the broader high yield market,” said Chen.
The environment is now especially supportive, with economic growth robust and domestically-focused US companies generating strong revenues and profits as well as stable cashflows.
Investors have already noticed, and high yield bond yields have fallen sharper than US treasury yields and spreads have narrowed to less than 300 basis points (bps).
“Yet absolute yields are still attractive at 7-7.5% and offer a significant premium over investment grade bonds whose spreads have contracted to historical lows of around 80bps,” said Chen.
Even after a strong performance during the past three years, there are still plenty of opportunities for investors in the high yield bond market.
*Allianz US Short Duration High Income Bond AM NAV USD fund was the Platinum award winner for the High Yield category at the Fund Selector Asia Hong Kong Fund Awards 2025.
