26-01-2021 · Insight

High yield indices don’t make good benchmarks

Certain features that are typical of high yield corporate bonds impose costs on high yield portfolios. These costs are not reflected in high yield indices, which means that portfolio managers are put at a disadvantage and that returns of passive high yield funds are structurally lower than the index.

    Authors

  • Patrick Houweling - Co-Head of Quant Fixed Income and Lead Portfolio Manager

    Patrick Houweling

    Co-Head of Quant Fixed Income and Lead Portfolio Manager

  • Sander Bus - CIO High Yield, Portfolio Manager

    Sander Bus

    CIO High Yield, Portfolio Manager

  • Robbert-Jan 't Hoen - Researcher

    Robbert-Jan 't Hoen

    Researcher


How is it possible that so few active high yield managers outperform their index, and that passive managers lag theirs by more than their management fee? Our research shows that a high yield index is not a useful benchmark for evaluating portfolio returns, and that an alternative approach is needed.

High yields come at a cost

High yield corporate bonds offer several attractive investment features, such as coupon rates and returns that are higher than that of investment grade assets. This comes at a cost, of course. This sector of the credit market also presents challenges for investors, such as limited liquidity, defaults, rating migrations and bonds that are callable before maturity. These characteristics imply a variety of costs that are not reflected in the index returns. The underperformance of passively managed ETFs, for instance, illustrates the difficulties of generating index-like returns in the high yield market.

As long as indices do not contain all the costs that accrue in practice, high yield indices are not a fair reflection of the potential returns from a high yield credit portfolio. This means that they are not suitable as benchmarks for evaluating fund manager performance.

What would be a better performance yardstick?

Our recommendation for investors in high yield funds is to compare portfolio performances with one another, rather than with an index.

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