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Short Summary
Main recommendation: Think twice about owning high-yield bonds; Ben Felix does not recommend them in the portfolios he oversees, and if you do hold them, keep them to a small share of fixed income. The video argues that high-yield bonds behave much like stocks, so they do little to provide the stability bonds are normally held for, and they have not added risk-adjusted value historically.
Key Points
- High-yield bonds are rated BB or lower by Standard & Poor's, and they are riskier than safer bonds, with higher yields to compensate.
- A 2001 study by Elton, Gruber, and Agrawal found that high-yield bond returns can mostly be explained by equity returns, meaning they carry much of the same risk as stocks.
- About 3.4% of high-yield bond issuers have historically been unable to pay bondholders, and bondholders have typically recovered a little less than half their investment in those cases.
- In a 2015 Larry Swedroe comparison, portfolios with high-yield bonds outperformed by only 0.2 to 0.5 percent per year, but with significantly higher volatility, so they added no value on a risk-adjusted basis.
- David Swensen, Yale endowment chief investment officer, criticized high-yield fixed income in Unconventional Success, and the video notes high-yield bonds are tax inefficient because their coupons are fully taxable as income.
Details Worth Noting
- Concrete instructions: If you choose to include high-yield bonds, limit them to a small portion of your fixed income holdings. Diversify broadly, for example through a low-cost high-yield bond ETF. Do not buy individual high-yield bonds.
- Rick Ferri, an evidence-based author and portfolio manager, does include high-yield bonds in his portfolios, so the view is not unanimous.
- The 2015 Swedroe comparison used four portfolios: one with all fixed income in safe five-year Treasury bonds and three with increasing allocations to high-yield corporate bonds.
- Because the tax treatment is unfavorable, high-yield bonds are described as a very tax-inefficient way to get equity-like exposure.
- The video frames these points as general investment commentary, not professional advice for any individual's situation.
Bottom Line
Unless you have a specific reason and accept the equity-like risk, high-yield bonds are hard to justify as a stability holding, and if you use them at all, keep the position small and diversified.
