High yield: strategic allocation

May 8, 2019

We argue that most institutional investors funds would benefit by holding an allocation to high yield bonds, and we discuss how much of a portfolio’s assets should be so allocated since the level is highly valuation-dependent.

Meketa Investment Group recommends that most diversified long-term pools consider allocating to high yield bonds, and if they do so, between five and ten percent of total assets in favorable markets, and maintaining a toehold investment even in adverse environments to permit rapid re-allocation should valuations shift.

We begin by providing background information on high yield bonds. We then proceed to discuss the three major risks inherent in high yield bonds: liquidity risk, default risk, and interest rate risk. In the following section, we analyze the return behavior of high yield bonds, including the characteristics of expected return, volatility, and correlation with other asset classes. We then proceed to evaluate the case for high yield bonds by comparing their use in a strategic and tactical context. The last section deals with issues an investor would face after deciding to invest in high yield bonds.