High Yield Bonds for Better Portfolios

Replacing a portion of a European portfolio’s equity holdings with high yield bonds boosts risk-adjusted returns. That becomes particularly clear when judging risk based on how far portfolios fall during market slumps, according to our analysis.

Investors who use traditional metrics such as volatility to measure the riskiness of their portfolios are in danger of underestimating likely losses during big market slumps.

Unfortunately, the returns of assets – and in particular equities and high yield credit – are not normally distributed (ie they don’t look like a bell curve). For riskier asset classes, this makes volatility a fatally flawed metrics since return distributions exhibit so-called fat-tails: steep losses are both more frequent and more severe. The use of volatility will therefore lead to a significant underestimation of the real risk in the portfolio.

Instead, value-at-risk (VaR) – an alternative method – is better at gauging the downside for their portfolios. And VaR makes it clear that investors looking for maximising a portfolio’s returns while minimising drawdowns should be holding high yield bonds.

We find VaR95%, which estimates the maximum loss assets will suffer with a confidence interval of 95%, to be a particularly useful measure. This then guides investors on how to mitigate portfolio losses.

We looked at seven major groups of European assets: cash, short-term and longer dated government bonds, short-term and longer dated investment grade bonds, high yield bonds and equities. We then assessed their performance during the period from 2014-2025. We chose that particular timespan because it was one in which equities performed very well – contrary to the previous decade.

We found that high yield bonds had a Var95% of -2.4%, exactly the same as longer-dated government bonds, but with an average monthly return of 0.32% against 0.02%.

Not only does high yield compare well with what are commonly seen as the safest of instruments, it also stacks up favourably against stocks. So while equities offer roughly double the average monthly return of high yield, at 0.7%, they also experience far greater losses – with a VaR95% of -6.6% against high yield’s -2.4%. At the same time, equities suffered a maximum drawdown of 25% against just under 16% for high yield bonds during that period (see Fig. 1).

What’s more, we find that for any risk preference – how much downside investors are willing to stomach – substituting high yield bonds for equities results in a better return in a model multi-asset portfolio. In other words, high yield is a more efficient asset class.

We constructed portfolios based on the asset types we analysed for each theoretical maximum monthly VaR95%, from -0.1% to -2.2%. Each portfolio had either fixed income or equities together with a mix of cash and other bonds. We found that above the very lowest risk rating (where the portfolio is made of the safest asset classes) in each case the portfolio with high yield debt generated a better risk-adjusted return than the one with equities (see Fig. 2).

We also determined, given a (VaR) risk budget equivalent to a standard balanced portfolio of 40% equities and 60% investment grade bonds, that over our sample period, an optimal portfolio would have been 68% high yield and 32% equities.

High yield debt delivers steady returns with moderate and short-lived drawdowns and strong rebounds thanks to the benefits of contracted coupon payments and  bonds’ pull-to-par nature – the fact that bond prices are drawn towards par as they approach maturity. By contrast, there is no predictable valuation that anchors equity prices, while dividends are always vulnerable to being cut. 

For investors wanting to minimise their likely losses during sharp market corrections,  Value-at-risk is a better measure of risk than volatility alone. And VaR makes it clear that high yield bonds should be a core asset allocation in a multi-asset portfolio, even during periods when equities deliver strong returns. But even for those investors with a focus on volatility as a risk measure, high yield remains an essential part of the portfolio with moderate risk levels.

Although our work was primarily on European assets, an analysis of US markets generates the same conclusion: multi-asset portfolios offer a better risk-return profile with high yield replacing part of the equity allocation, even during periods when equities do particularly well.