A slow and steady approach to the high-yield bond market

High-yield—now vs. 2007

2022 was a rough year for fixed income in general and the high-yield corporate sector was no exception. We’ve seen a lot of volatility in 2022 translate into a lot of dispersion—which means the market is pricing in the risk of riskier credits by making those bonds cheaper—within the high-yield market.

Overall, high-yield is better-positioned today. The composition of outstanding debt is at a much higher quality level than what we saw just prior to the global financial crisis. Bonds that are rated BB make up a much larger portion of the market now, while those rated CCC make up a much lower proportion.

In the run-up to the global financial crisis, we saw a lot of aggressive underwriting, which created a lower-quality market. It’s not that aggressive underwriting hasn’t occurred over the past decade, but that we’ve seen this activity occur in adjacent markets. Those markets include the bank loan market and the private credit market, the latter of which is relatively new yet rapidly growing over the past decade. These are markets that typically provide alternative sources of financing for the types of aggressive deals that have previously been seen in the high-yield market. 

Also, merger-and-acquisition activity has shifted to more strategic buyers in the post-GFC era, replacing private equity firms, which tend to employ a large amount of debt leverage when buying companies. This helps to partially explain the significant growth in the investment-grade market and lower levels of issuance in traditional high-yield corporate bonds. In a nutshell, these events have left us more comfortable with the potential returns of high-yield as we move into an upcoming period of expected recession.

Our outperformance strategies

The high-yield team at Vanguard seeks to generate outperformance through three primary strategies: first, by having a structural higher-quality bias; second, through issuer diversification; and third, via our bottom-up security selection process. If you look at it empirically, this three-pronged approach is a time-tested way to potentially outperform over the long term.

In the fixed income space—the high-yield segment included—the ability to be up in quality is a real advantage. Fixed income risks are asymmetric, usually with much more downside than upside. So, our advantage is tied to our low fee structure, which allows us to be more patient and disciplined about selecting high-quality issues, particularly when spreads are tight relative to our competitors.

We have a collaborative, world-class team that we’ve built from the ground up, attracting high-caliber people from other world-class institutions and from within our own ranks here at Vanguard. We’ve grown from a team of four in 2017 to 13 team members today. The combination of our deeply knowledgeable team and collaborative process gives us the ability to be nimble and opportunistic, even during less-attractive market conditions.

Our team’s diversity of experience helps with security selection but, when spreads are tight, you can’t outperform with beta. Similarly, when dispersion is low, it doesn’t matter if you have a strong team. In the current environment, when dispersion is high but spreads are tight, we’re able to play to our strengths. We can practice patience and wait for better entry points but can also take advantage of our team’s experience to identify the winners.

Finally, our portfolios are true-to-label. You know what you’re getting. Our benchmark construction allows us to show investors which asset classes they will be invested in, most of the time.

It’s also worth mentioning that Vanguard has invested a lot in building out its high-yield business. We’re here for the long term. We see a lot of attractive opportunity for active managers within high-yield.

Introducing the Vanguard Multi-Sector Income Bond Fund

In 2023, we introduced the Vanguard Multi-Sector Income Bond Fund (VMSAX) to the public for investment. We think it is a worthy addition to our fixed income fund lineup and believe that it will appeal to investors who are seeking to generate a diversified income stream through allocations in investment grade corporate, high yield and emerging markets.

VMSAX features a low expense ratio at 30 basis points, allowing us to maintain a patient and disciplined approach in capitalizing on opportunities within credit-focused sectors. The fund’s structure will also allow us additional flexibility to fully optimize our specialist teams’ insights at the asset class and bottoms-up selection levels.

Learn more about VMSAX on the Vanguard website.

Notes:

For more information about Vanguard funds, visit vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, expenses, and other important information are contained in the prospectus; read and consider it carefully before investing.

All investing is subject to risk, including possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments. 

High-yield bonds generally have medium- and lower-range credit quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit quality ratings. Investments in bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.