Amid a yield surge over the last two years, investors have stashed hordes of cash in money market funds and other high-quality, short-maturity instruments. For example, assets in U.S. money market funds reached a record-high of $5.9 trillion in late 2023 and topped $6 trillion in mid-February 2024. This marked a 25% increase from the end of 2021 when assets totaled nearly $4.8 trillion.1
Thanks to the Federal Reserve’s (Fed’s) aggressive rate hikes, investors in money market funds and other high-quality, short-maturity securities have enjoyed generous yields. Since the first half of 2023, U.S. Treasury bill yields have remained at or above 5%.2 Yields haven’t been that high since the global financial crisis of 2007-2009.
But with the Fed likely to cut rates in 2024, reinvestment risk is rising. Reinvestment risk refers to the possibility of investors being unable to reinvest cash assets at a rate similar to their current return rate.
Once the Fed starts easing, we expect yields across all maturities, including money market securities, to likely decline. At the same time, bond prices will likely rise. We believe investors who wait to add back risk and duration to their portfolios may face a less-attractive market backdrop.
Waiting to Re-Risk May Be Risky
Investors waiting for the “best” time to add back risk to their portfolios could potentially miss the opportunity to lock in attractive yields. For those willing to accept the higher credit risk and liquidity risk of high-yield corporate bonds, we believe today’s climate offers attractive opportunities.
High-yield bond prices tend to gap, and outsized returns have historically occurred over short time horizons. For example, during the five years ended December 31, 2023, the ICE BofA US High Yield Constrained Index returned 5.2% annualized.
For investors who were out of the market during the five best-performing months of this period, the annualized total return declined to 0.3%. The annualized total return dropped to -3.9% for investors who missed the best 10 months during the five-year period.3
Today’s High-Yield Metrics Appear Historically Attractive
The high-yield index’s yield to worst was close to 8% in mid-February, historically an attractive entry point for investing in high-yield bonds.4 This level put the index in the cheapest yield quintile of the last 10 years.5
In our view, investors trying to time their high-yield allocations face a challenging task. They risk missing the few days or weeks of performance that could contribute disproportionately to longer-term returns.
Bond Outlook Favors High-Yield Over Investment-Grade Corporates
We remain upbeat about the performance prospects for high-yield and investment-grade corporate bonds in 2024. But we believe high-yield bonds may offer potential benefits in today’s environment:
Rates: All else equal, the yield advantage over investment-grade corporates may help high-yield bonds outperform in a flat or gradually declining rate environment.6 If rates unexpectedly move higher, we believe the high-yield market's shorter duration would likely boost outperformance versus longer-duration credit.
Yield: Investors using their cash-equivalent investments to re-risk their portfolios may want to consider high-yield bonds. Compared with six-month Treasury bills, high-yield bonds (shown in green) recently offered a yield pickup of 2.25 percentage points, as Figure 1 illustrates. Investment-grade corporates (shown in blue) provided a yield pickup of only 0.07 percentage point.
Economy: We believe investment-grade corporates would likely outperform in a hard economic landing where spreads widened and Treasury yields declined. However, given the economy’s persistent strength, we don’t believe there’s a high probability of a hard-landing scenario.
Brett Collins, CFA, is a client portfolio manager in the New York office of Nomura Corporate Research and Asset Management, Inc. (NCRAM). Primarily engaged in managing assets consisting of U.S. high-yield corporate bonds, NCRAM also manages emerging market debt, U.S. leveraged loan portfolios, global high yield and European high yield.
Nomura Holdings and American Century Investments forged a strategic partnership more than seven years ago that is rewarding for each firm’s clients. In May 2016, Nomura Holdings acquired a non-controlling, 41% economic interest in American Century Investments. Nomura Holdings, Inc. holds two of 11 seats on the board of directors at American Century Companies, Inc.
