Investors weigh high yield allocations while Fed mulls rate cuts

As the Federal Reserve decides what to do with interest rates, fixed income investors are wondering whether it's time to take out the junk...bonds that is.

John Sheehan, portfolio manager for the Osterweis Strategic Income Fund (Ticker: OSTIX), for one, is hanging onto his high yield.

“We don't speculate on what the Fed's going to do, or on the election, and this is a conducive environment for taking what the market gives us,” said Sheehan.

Sheehan is accepting the Fed’s largesse by holding a preponderance of high quality, short duration bonds, both in the high yield and investment grade markets. His fund, up 3.65 percent through the end of June, yields 5.4 percent. By comparison, the iShares Core US Aggregate Bond ETF (Ticker: AGG) is down 1.2 percent this year and yields 3.4 percent at last check.

Meanwhile, the SPDR Bloomberg High Yield Bond ETF (Ticker: JNK) is flat so far this year, while yielding 6.6 percent.

Josh Flade, deputy CIO at Orion, believes high yield is well positioned over the next twelve months due to continued strength in the US Economy thanks to "dovish Fed talk in Q4 of 2023 and the wave of AI related investing that has swept the markets in 2024."

“While we recognize that the spread investors are paid above treasury bonds is relatively tight at just north of 3% right now, the overall yield in high yield at almost 8% is compelling,” said Flade.

Cyrus Amini, chief investment officer at Helium Advisors, is staying overweight high yield bonds, seeing a positive risk/reward in the sector as "yields are attractive and defaults have remained well below their 25-year averages with the notable exception of CCC-rated bonds."

“Many of the issuers in this space strategically refinanced when rates were low. This, combined with a maturity wall that doesn’t exceed investment grade until approximately 2027, adds more positive drivers for high yield versus other sub-sectors as well as the Bloomberg Aggregate Index,” said Amini.

GROWING MORE CAUTIOUS

Will Sterling, partner at TritonPoint Wealth, says he is maintaining his strategic asset allocation weighting to high yield bonds – remaining neither overweight nor underweight. Unlike Amini, however, he is growing increasingly cautious on the asset class, believing elevated interest rates will indeed pinch recent high yield issuers. 

“Given that the majority of the high yield market was issued in 2020 and 2021, issuer refinancings are likely to have a substantial impact on cash flows even if the Fed cuts rates by 50 basis points before year-end as the market is currently pricing,” said Sterling. “The longer the Fed keeps rates high, the more problematic it becomes for issuers.”  

Craig Warnimont, chief investment officer of Venture Visionary Partners, admits he has done well with high yield over the past year, primarily through the iShares iBoxx High Yield Corporate Bond ETF (Ticker: HYG). Nevertheless, he feels it is time to “start seeking options for yield that have historically had less downside risk in the bond category.”

“While a strong economy could extend good performance for high yield for several more years, we like the idea of getting yields of 6 percent or higher from high quality issuers like U.S. Government agencies as well as some of the largest banks in the country which we expect will provide better downside protection if any level of fear or uncertainty returns to the markets,” said Warnimont.

Callie Cox, chief market strategist at Ritholtz Wealth Management, agrees that high yield bonds have benefitted from the US economy constantly surpassing everyone’s expectations. And she too feels it might be time to dial back on risk.

“There’s a lot of pressure on the economy, though, and we’re starting to see some weakness in the job market. At this juncture, it may make more sense to protect your portfolio with more quality or government bonds in case growth breaks down,” said Cox.