High-yield-bond funds have been among the best performers since the financial crisis, but Mike Roberge, chief investment officer at MFS Investment Management, thinks that it is time for investors to move their high-yield allocation into stocks.
High-yield-bond funds have a five-year average annualized return of just under 15%, nearly on par with the 15.91% five-year average annualized return of large-cap funds, according to Morningstar Inc.
In months to come, however, Mr. Roberge expects those returns to decouple — with stocks the clear winners, he said Thursday at the UBS Wealth Management CIO Global Forum in New York.
Usually the case against high yield is built around worries about the economy, since the below-investment-grade bonds' risk of default jumps during downturns. It's not default risk that has Mr. Roberge worried.
Instead, the current price of the bonds and their low yields have persuaded him that stocks are now a better bet.
Most high-yield bonds are either trading at par or a premium, thanks to number of yield-hungry investors who have piled into the space. At those prices, there isn't much, if any, room for capital appreciation, unless interest rates fall further.
“High yield is totally dependent on the [Federal Reserve] to get a higher return than the coupon,” Mr. Roberge said in an interview.
Today's high-yield coupons, or their yield, are a far cry from what investors are used to because of the extra attention that the asset class has received. The Barclays U.S. Corporate High Yield Index, for example, has an average yield of 5.73%, far below the double-digit yields to which investors were treated in the past.
“High-yield rates have fallen so low that you now have interest rate risk,” Mr. Roberge said.
“Historically that hasn't been the case,” he said. “There used to be a cushion.”
It all adds up to a strong case against high-yield bonds keeping up with stocks, if one thinks that the economy will continue growing, as Mr. Roberge does.
“You're paying par or a premium for a market that has no upside, that still has economic risk and now has interest rate risk,” he said.
“We're not anti-fixed income, but if you want to take economic risk right now, we prefer equities. They have more upside and offer better inflation protection,” Mr. Roberge said.
(Disagree? Check out an opposing view: For near-term boost, go with high-yield fixed income)