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Do Junk Bonds Pay Off in the Long Term?

With interest rates near zero, a lot of investors have gone deeper into risky areas of the debt market in the search for yield. For those investors, there is some reassuring news: A look at the long-term data for some of these sectors suggests that such investments can be worth the risk.

In the hunt for yield, many investors have opted for low-grade municipal and corporate debt, or “junk” bonds. Such instruments are considered high risk because, while they can pay off over the long run, they can also go south quickly in times of market drops and panics. That is a level of volatility a lot of debt investors cannot stand. 

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Examining all high-yield bond mutual funds over the past 30 years, an interesting trend emerges: If you are disciplined and avoid cashing out at the wrong time, high-yield debt can pay total returns near to those of U.S. stocks. Since 1990, the average high-yield debt fund has delivered an average annual return of 7.1% with a volatility of 7.7%. Compare this with the average short-term U.S.-bond fund, which delivered 3.8% with a much lower volatility of 1.5% over the same period. The returns for high-yield bond funds thus don’t really resemble debt at all in a lot of ways, and actually look a lot more like equity. Over the same period, since 1990, the S&P 500 delivered an average annual return of 7.8% but with a high volatility of 14.5%.

 

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