Finding High Yielding Fixed Income Investments
In recent years, low rates on U.S. Treasuries and other lower-risk investments have fueled rising demand for high-yielding investments. Fixed-income investments are municipal bonds, corporate bonds, government bonds, and Treasury bonds that pay returns on a fixed schedule. They are generally categorized into low-, intermediate-, and high-yield offerings, each with an increasing level of risk.
There are different types of bonds that investors can use to boost their yields, in different bond market segments. These types vary between longer-term lengths and higher risks. The types to consider are investment-grade corporate bonds, high-yield bonds, senior bank loans, foreign corporate bonds, and high yield municipal bonds.
Two Considerations for Finding Yield
There are two characteristics to look for in the bond market for finding the highest yield—term length and risk. Long-term bonds tend to offer higher yields than their short-term counterparts. Long-term investors want higher compensation for the additional risk they take since more can go wrong within a ten- to 30-year period than in a shorter interval.
Higher yield always comes with higher risks. Understand your risk tolerance to keep from losing your principle.
Investors can also find higher yields in the segments of the bond market that come with above-average credit risk (the risk of losing portions of the principle and interest). Keep in mind that there are times when long-term issues don’t offer much of an advantage over shorter-term bonds—a condition known as a flat yield curve—where very little difference between long-term and short-term bond yields exists.
Investment Grade Corporate Bonds
Corporate bonds are a lower-risk way for investors to pick up extra yield, especially if they focus on higher-quality or shorter-term issues. For example, from 1997 through 2020, investment-grade corporate bond yields have been greater than yields from U.S. Treasuries.
The tradeoff for this higher yield is a higher level of risk than an investor would experience in Treasuries since corporate bonds are influenced by both interest rate risk (the impact of rate movements on prices) and credit risk.
Over time, investors have been paid for this risk: in March 2020, the S&P 500 Investment Grade Corporate Bond Index had a 10-year annual return of 5.44%, outpacing the 3.57% return of the broader investment-grade bond market, as gauged by the S&P U.S. Aggregate Bond Index.
The long-term BloomBarc US 10+ Year Corp Index performed even better, producing an average annual return of 8.43%.
High Yield Bonds
High yield bonds are one of the riskiest areas of the bond market, and their volatility is often close to what an investor could expect from stocks. However, high yield bonds continue to be one of the most sought-after investments among those who need to boost their investment income.
From 2009 through 2019, high yield bonds have averaged a yield advantage of 4.26 percentage points over U.S. Treasuries. As of January 31, 2020, the total returns of the Credit Suisse High Yield Index produced an average annual total return of 6.74% percent, while U.S. Treasuries averaged 2.48%.
High yield bond return is over two percentage points better than the investment-grade market. While high yields have fallen behind the stock market, as gauged by the 10.38% average annual return of the S&P 500 Index, they are still important components of an income portfolio—as long as you’re comfortable with the risks.
Senior Bank Loans
Senior bank loans are a previously obscure asset class that is growing in prominence amid investors’ frantic search for higher-yielding alternatives. Senior loans, also referred to as leveraged loans or syndicated bank loans, are loans banks make to corporations and then package and sell to investors.
Since the majority of these senior bank loans are made to companies rated below investment-grade, the securities tend to have higher yields than the typical investment-grade corporate bond.
Senior loans are more vulnerable to default than bonds.
At the same time, senior loans typically offer a yield of about 2% less than high yield bonds. The funds that invest in this area tend to be less volatile than those that focus on high-yield bonds.
One of the most compelling aspects of bank loans is that they have floating rates, which provide an element of protection against rising rates. Funds that invest in senior loans can typically be expected to offer yields about two to three percentage points above broad-maturity U.S. Treasury funds.
Foreign Corporate and High Yield Bonds
Until just recently, there were very limited options to invest in corporate and high-yield bonds issued by companies outside of the United States. However, the current demand for higher-yielding investments has led to the birth of numerous mutual funds and exchange-traded funds dedicated to this space.
The yields are high: funds this area will offer yields anywhere from three to six percentage points above U.S. government bond funds. But again, caution is necessary: risk is high, and when the markets are hit by broad economic concerns or major international news events, these funds tend to take it on the chin.
Still, those who have a long-term time horizon and a higher tolerance for risk can take advantage of this relatively new and growing asset class to boost their income and augment their portfolio.
High Yield Municipal Bonds
Investors in higher tax brackets have the option of investing in high-yield municipal bonds, which are the bonds issued by government entities with lower credit ratings. Funds that invest in this area will typically offer yields about 1.5–2.5 percentage points above funds that focus on investment-grade, pre-tax based municipal bonds (munis).
While volatility is higher in this area of the market, longer-term investors have been paid for the risks. Due in part to their yield advantage, high-yield munis have outperformed their investment-grade counterparts over the past decade.
Finding Yield Outside of the Bond Market
There are also a number of higher-yielding (and higher-risk) investments outside of the bond market, including:
- Convertible bonds
- Dividend-paying stocks
- Utility stocks
- Real estate investment trusts
- Master limited partnerships (MLPs)
- Preferred stocks