Return, Risk, and Diversification

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When assessing a portfolio and determining their asset class mix, investors often allocate large portion to equities as this is believed to have a much better longer-term investment return profile than “bonds,” while “bonds” are considered less risky and offer a diversification benefit to a portfolio. Balancing return, risk, and diversification are import factors. As we look at today’s investment landscape, for those concerned about escalated equity valuations, we believe that high yield bonds may offer investors a viable alternative to a piece of their equity exposure.

Though high yield bonds are bonds/fixed income securities, it is important for investors to understand that over their history, they have had a similar return profile as equities (as measured by the S&P 500) but with significantly less risk.1

Here we are measuring risk as volatility, or the standard deviation of returns. Looking back over the high yield market’s 30 year history of existence, the return/risk metric above demonstrates that the high yield market has significantly outperformed equities on a risk adjusted basis over various historical periods, providing a higher return per unit of risk.

Diversification is also a consideration, and one way to analyze that is to look at the correlation of various asset classes.2

30 Year Correlation of Various Asset Classes

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