When Tactical High Yield can Potentially Boost Fixed Income Performance

See how investors have used trend following strategies in high yield credit to improve traditional buy-and-hold portfolios.

Investors with greater risk tolerance may be more focused on increasing their annual returns than other investors. Achieving this objective prudently means identifying investments with historically strong risk-reward profiles.

Tactical trend following in high yield credit can help investors target higher returns compared with traditional buy-and-hold portfolios. Even a modest re-allocation to tactical trend following can improve a portfolio’s risk-reward profile. The below comparison from the Portfolio Analyzer page reflects this.

The historical effect of replacing a bond allocation with tactical high yield has been increased returns and a modest increase in portfolio drawdowns. When performing annual rebalancing, the total portfolio impact over the evaluation period was approximately +3.1%, or +0.25% per year.  A fall 2007 investment of $100,000 in a 60/20/20 equity/fixed income/tactical portfolio would have returned a higher final value than the traditional 60/40 portfolio.

From a maximum drawdown (downside risk) perspective, the portfolio at its worst point in time was down only 1.8% more than the base case portfolio.

Tactical trend following in high yield credit has a historically attractive risk-reward profile, offering reasonable returns while meaningfully reducing drawdowns.

Your Fixed Income Benchmark Matters

The choice of fixed income benchmark is key in such analysis.  7-10 year Treasuries have relative high duration, or interest rate sensitivity. This higher duration tends to offset equity volatility in a portfolio. (When stocks are going down, interest rates tend to fall, causing high duration securities to rise in price.)  In the real world, many advisors may prefer their fixed income portfolios have less duration exposure, mainly due to fear of risks from potentially rising interest rates. To reflect those circumstances, we included the Bloomberg Barclays Aggregate Index as an example of a bond index with lower duration.

When pitting three fixed income benchmarks against each other, one can see relative gains have been earned by switching into tactical high yield strategies (symbolized by HYTREND).

Over the period, on a standalone basis the HYTREND index outperformed the Bloomberg 7-10 year Treasury Index and the Bloomberg Barclays Aggregate Index by 1.8% and 2.5% on an annualized basis, or positive 0.37% and 0.51% per year respectively to the portfolio when considering a change to only 20% of the total portfolio allocation.

Conclusion

Because high yield trend following has a more attractive risk-reward profile than stocks, as measured by its Sharpe ratio, allocating to this tactical strategy rather than increasing stock market exposure can be an attractive way to increase expected portfolio returns.

Investments cannot be made in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Past performance is no guarantee of future results.

The material provided herein has been provided by Counterpoint Mutual Funds, LLC and is for informational purposes only. Counterpoint Mutual Funds, LLC serves as investment adviser to one or more mutual funds distributed through Northern Lights Distributors, LLC member FINRA/SIPC. Northern Lights Distributors, LLC and Counterpoint Mutual Funds, LLC are not affiliated entities

Other Insights

Potential Ways to Improve Account Drawdowns in Retirement​

The right fixed income diversifier has historically reduced portfolio declines, especially during challenging markets.

Portfolio Analyzer: Matching Asset Mix to Your Risk Preference

Explore how tactical high yield strategies have improved portfolio performance and Sharpe ratio based on an investor’s risk preference.

Ready to learn how CP ETFs can potentially improve portfolio performance?