High-Yield Bond Funds Correlation With Equity

[brewer12345]

Stay away from junk right now. Vastly overpriced.

[audreyh1]

For those of you wishing to "goose" your bond allocation by having some exposure to the junk category, I suggest you invest through a "Total Return" type bond fund. These bond funds usually have a smattering of the more risky bond asset classes such as high-yield, foreign, emerging market as well as others such as TIPs. They are usually intermediate term in duration. This lets you rely on the fund manager to decide when junk (or other) is good value or not, and let him/her do the timing for you.

A few years ago I decided that I didn't want to hold bond funds in each bond asset class - way too much of a hassle. I could see how at times high-yield or treasuries or mortgage-backed each became wildly overvalued, and I just got tired of it. I also didn't want to mess with a separate TIPs fund or a separate foreign bonds fund. So I went to the total return fund approach for a portion of my bond allocation.

I have 30% of my bond allocation split between Metropolitan West Total Return MWTRX and Fidelity Strategic Income FSICX. MWTRX provides the bulk of the high-yield exposure, although it wanders over all bond asset classes as it deems prudent. FSICX takes a "bar bell" approach with US govt debt/Tips on one end and high-yield, foreign debt and emerging market debt on the other. The remaining 70% bond allocation is in plain vanilla short/intermediate higher-quality "core" bond funds (DODIX and MWLDX). I am very happy with my current approach and am able to leave it well alone (a good indication that it's working for me long-term and across many market conditions).

PIMCO and other companies have total return funds as well. FSICX is actually considered a "multi-sector" bond fund.

Audrey

[Telly]

Thanks to all that responded to my question!

alec - Thanks for the Swedroe link. There was some good discussion and outlining of points by Swedroe. It strongly reinforces my original thoughts on why H-Y was not for me.

boutros - Thanks for running the correlation exercise! So H-Y Bond Index vs. S&P500 Index resulted in a correlation of +.54 over the last 21 years. Interesting.
So I should expect that, say, an intermediate-term bond vs. the S&P500 would result in a much much lower correlation value over the same range of years. I guess I would expect it to be below zero, negative, but I have no idea by how much.

[ats5g]

Quote:

Originally Posted by Telly Thanks to all that responded to my question! alec - Thanks for the Swedroe link. There was some good discussion and outlining of points by Swedroe. It strongly reinforces my original thoughts on why H-Y was not for me. boutros - Thanks for running the correlation exercise! So H-Y Bond Index vs. S&P500 Index resulted in a correlation of +.54 over the last 21 years. Interesting. So I should expect that, say, an intermediate-term bond vs. the S&P500 would result in a much much lower correlation value over the same range of years. I guess I would expect it to be below zero, negative, but I have no idea by how much.

I would say that intermediate term high quality bonds [like treasuries] will be uncorrelated with equities, meaning that sometimes they will be more highly correlated and sometimes they will be more lowly correlated, or even negatively correlated, with equities.

For your viewing pleasure, here are the rolling three-year correlation between S&P 500 and long-term U.S. Government bonds:

1967-2003



1930-2003



- Alec

[FIRE'd@51]

If real rate changes are driving interest rate changes (everything else equal), both bonds and stocks would move up and down together (highly correlated) because the discount rates for both payment streams would rise or decline together. If interest rates are changing due to changes in inflation expectations, the correlation will be much lower (since stocks can flow through much of that inflation into higher earnings). In this case, for stocks, the higher discount rate is largely offset by higher nominal earnings growth. If fear (i.e. flight to credit) is driving discount rates, stocks and Treasuries (or high quality bonds) could move in opposite directions (negative correlation).

I ran a regression with annual data over the same time period as boutros' correlation data, and got a correlation coefficient between LT Treasuries and the S&P 500 of about 0.2, significantly less than the high-yield results, which is what I would have intuitively expected.

[mathjak107]

Quote:

Originally Posted by JPatrick Take a peak at FAGIX--A touch different from the typical HY, but those 5 year returns are really juicy. Yes it does have a track similar to equities. Not a HY fund, but one that is pretty steady is FFRHX. Higher yield than MM and IMO not that much more risk. And...no real equity correlation. I really don't have any feelings one way or the other as to the timing of new purchases.

ffrhx is a very very short term hi yield fund . its the very short duration that takes alot of the risk away. it also takes away alot of the gains too. i use ffrhx as a step up from a money market.