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The Merits of High Yield 1
The moniker “junk” may be a misnomer for high yield, despite that fact that these bonds possess a credit
quality less than investment grade. In actuality, high yield bonds typically have a superior claim on company
assets in bankruptcy relative to equities and often have associated covenants limiting company actions that
may be detrimental to bond holders (something that investment grade bonds typically do not have).
In this paper, we would like to investment grade index of just 0.27, versus a correlation of 0.58
examine the two largest concerns to the US largecap equity index.
that investors typically have with With these characteristics in mind, we believe high yield should
the high yield asset class, (1) be treated as a third asset class – neither equity nor fixed income.
asset allocation and (2) timing of Given the market volatility experienced over the last few years as
investments. well as today’s continued economic uncertainty, investors should
In our opinion, taking the time to consider incorporating this third asset class into the traditional
fully understand high yield’s risk/ equity/fixed income mix. While equities generally represent the
Greg Hopper reward characteristics can be time larger percentage of investments (depending on factors such
Head of High Yield
Artio Global Management LLC well spent. as age, risk tolerance, etc.), we believe you should consider
replacing some of the ‘riskier’ assets in a portfolio with high yield
Asset Allocation (see Important Disclosures for high yield related risks). Moreover,
Let’s start by discussing why we believe a separate high yield given the idiosyncrasies of the asset class, investors should hire
allocation can be beneficial. First, as illustrated in Exhibit 1 an active high yield manager who understands the arcane world
below, from January 1985 through January 2012, high yield’s of “junk.”
Sharpe ratio (a measure of risk adjusted performance) of 0.64 is
higher than both largecap and smallcap US equities. Although Timing of Investments
the Sharpe ratio for investment grade bonds is higher, high The second concern regarding high yield deals with the
yield delivered annual returns averaging over 150 basis points timing of investing in the asset class. Many investors believe
(bps) more than investment grade bonds during this period. that the best period to initiate a high yield investment is
While high yield returns should always be viewed in terms when the economy is coming out of the depths of recession.
of incremental risk relative to the investment grade index, we However, once the short-term equity-like appreciation typically
note that since January 1985, high yield has a correlation to the experienced by high yield investments in this environment ends,
investors often become nervous about the asset class and sell
Exhibit 1 on the belief that the newly tightened yield spreads suggest
Risk Characteristics extreme downside risk.
While it is true that periods of economic recovery typically
Investment Smallcap US Largecap US
Grade Bonds Equities Equities generate the strongest absolute high yield returns, these are
Average Annualized not necessarily the periods when high yield presents the best
9.58% 8.00% 9.56% 10.52%
Monthly Return relative value. Equities are usually the highest returning vehicle
8.07% 4.21% 20.00% 15.69%
when emerging from a recession, just as high grade bonds
are normally the best harbor during downturns. Meanwhile,
Sharpe Ratio 0.64 0.84 0.26 0.39 investors who follow the typical pattern of trying to time their
entry into high yield may forego the higher relative returns that
Correlation to High
1.00 0.27 0.61 0.58
Yield Index coupon payments provide in other periods – primarily during
times of stable growth or periods when the economy is going
Source: Bloomberg and Artio Global Management. High yield represented by the BofA ML US
High Yield Cash Pay Index; Investment Grade Bonds represented by the Barclay’s Capital US through a “bottoming” process. Perhaps more importantly, an
Aggregate Bond Index; Smallcap US Equities represented by the Russell 2000 Index; Largecap
US Equities represented by the S&P 500 Index. Calculated using monthly returns. Past over-concentration in any of these asset classes during any
performance is not a guarantee of future results. Index performance is not illustrative
of fund performance. It is not possible to invest directly in an index. Please call 800 387
period implicitly assumes that the investor has an accurate
6977 or visit www.artiofunds.com for fund performance. forecasting ability with little probability of error. Most market
Artio Global Management LLC For registered investment professional use only. See Disclosures.
The Merits of High Yield
participants recognize the inherent uncertainty in any prediction to five year US Treasuries (“treasuries”). The current economy
and maintain at least some diversification across all asset classes can be characterized as slow growth, non-recessionary where
in most environments. spreads are wide relative to a low default rate. As of January
And what of the downside risks of high yield during those 31, 2012, the yield spread over treasuries was approximately
periods when the coupon should be providing an advantage 700 bps. If we use the historic average recovery rate of 40 cents
to the asset class? For those who still want to focus on the on defaulted high yield bonds, this spread implies that high
downside risk of high yield, we observe that during the yield could withstand an 11.7% default rate over the next year
period January 1985 through January 2012, the worst rolling and still break even. If we use a far more conservative recovery
12-month return for high yield (as measured by the BofA assumption of 25 cents, high yield could still withstand a 9.3%
Merrill Lynch US High Yield Cash Pay Index) was -31.21% for default rate before underperforming treasuries. According
the year ending November 2008, the height of the credit crisis. to Moody’s, the default rate as of January 31, 2012 was
While this was certainly a painful time, it compares favorably approximately 1.9% and is expected to remain low over the
to the worst rolling 12-month return of -43.32% for largecap next two years; the long-term average default rate is 4.2%.
equities and -42.38% for smallcap equities during the same This is a considerable decline from the almost 11% default
period (as measured by the S&P 500 and Russell 2000 Indexes, rate in November 2009, illustrating how high yield companies
respectively). have done an excellent job deleveraging their balance sheets
and generating substantial free cash flow. The room for error
Exhibit 2 that these numbers highlight suggests that high yield may
Best/Worst Rolling 12-Month Returns be a relatively better option than equities and perhaps even
investment grade bonds. The comparison to investment grade in
Investment Smallcap US Largecap US this environment will, of course, depend on market conditions
Grade Bonds Equities Equities
(which may vary considerably) and to a large degree on actions
Worst Rolling 12-Month
-31.21% -3.67% -42.38% -43.32% by the Federal Reserve and the course of inflation.
Best Rolling 12-Month
63.24% 28.72% 64.41% 53.62% In summary, we believe high yield may be considered a “third”
Source: Bloomberg and Artio Global Management. High yield represented by the BofA ML US asset class for most comprehensive asset allocation strategies.
High Yield Cash Pay Index; Investment Grade Bonds represented by the Barclay’s Capital US
Aggregate Bond Index; Smallcap US Equities represented by the Russell 2000 Index; Largecap
For mutual fund investors trying to determine an entry point or
US Equities represented by the S&P 500 Index. Calculated using monthly returns. Past who actively manage their high yield fund allocations around
performance does not guarantee future results.
some benchmark percentage, we believe it is important to
We feel that the best cure for the persistent focus on high yield’s consider the potential strength of the coupon flow relative to the
downside risk is to run a rough break-even analysis relative risks associated with high yield investing.
Important Disclosures objectives, the Fund may use certain types of exchange traded
The Artio Global High Income Fund’s investment objectives, funds or investment derivatives such as futures, forwards, and
risks, charges, expenses and other information are described swaps. Derivatives involve risks different from, and in certain
in the prospectus which must be read and considered carefully cases, greater than the risks presented by more traditional
before investing and may be obtained by calling 800 387 6977 investments. These risks are fully disclosed in the prospectus.
or visiting www.artiofunds.com. This material is provided for informational purposes only and does not
Mutual fund investing involves risk; principal loss is possible. The in any sense constitute a solicitation or offer for the purchase or sale
securities in which the Artio Global High Income Fund will invest of securities.
may be considered more speculative in nature and are sometimes The views expressed solely reﬂect those of Artio Global Management
known as “junk bonds.” These securities tend to offer higher yields LLC (“Artio Global”) and the managers of the Fund and do not neces-
than higher rated securities of comparable maturities because sarily reﬂect the views of any afﬁliated companies.
the historic ﬁnancial condition of the issuers of these securities The material contains forward-looking statements regarding the intent,
is usually not as strong as that of other issuers. High yield ﬁxed beliefs, or current expectations. Readers are cautioned that such
income securities can present a greater risk of loss of income and forward-looking statements are not a guarantee of future performance,
principal than higher rated securities. Investors in these securities involve risks and uncertainties, and actual results may differ materially
should carefully consider these risks and should understand that from those statements as a result of various factors.
high yield ﬁxed income securities are not appropriate for short-
term investors. Investments in debt securities typically decrease in The views expressed are subject to change based on market and other
value as interest rates rise. This risk is usually greater for longer- conditions. Furthermore, the opinions expressed do not constitute
term debt securities. investment advice or recommendation by the individuals, Artio Global,
the Fund, or any afﬁliated company.
Investments in asset backed and mortgage backed securities
include additional risks that investors should be aware of such as All material presented in this report, unless speciﬁcally indicated oth-
credit risk, prepayment risk, possible illiquidity and default, as well erwise, is under copyright to Artio Global Management LLC. None of
as increased susceptibility to adverse economic developments. the material, nor its content, nor any copy of it, may be altered in any
way, transmitted to, copied, or distributed to any other party, without
Investing internationally involves additional risks, such as currency the prior express written permission of Artio Global.
ﬂuctuations, social and economic instability, differing securities
regulations and accounting standards, limited public information, Artio Global Investors Inc. is the indirect holding company for Artio
possible changes in taxation, and periods of illiquidity. These risks Global Management LLC, the Adviser for the Artio Global Funds which
are greater for emerging markets. In order to achieve its investment are distributed by Quasar Distributors, LLC.
Artio Global Management LLC For registered investment professional use only.