Finding the Right Kind of Yield

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Sam Lau

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Samuel Lau, I’m a portfolio manager at DoubleLine Capital.

So as investors, we all know that yield matters. And in today’s challenging environment, it could be more difficult to find the right type of yield. And by right type of yield I’m talking about making sure that you’re getting compensated in exchange for the amount of risk that you’re taking. So in fixed income, there are really two primary risks to consider in any investment. The first is credit risk and the second is interest rate risk. And of these two risks, I believe that credit risk is the more benign, at this point in time. As we’re still in the midst of an economic recovery, which should be supportive to credit risk in general.

Additionally, the past 18 months or so since the depths of the pandemic has been marked by a series of accommodative fiscal, monetary, as well as credit conditions. And that all has allowed companies to recapitalize their balance sheets, leaving most of these companies in stronger credit positions as they’ve had a chance to refinance a lot of their existing debt into longer maturities at much lower yields they were held at previously. With that we’re seeing consumer debt vehicles are also seeing relatively low delinquency rates, as well as defaults over this period of time.

However, it seems that this series of accommodative policy also comes at a cost, and we’re seeing some of those symptoms today with the backdrop of rising rates due to the amount of increased debt that was needed to fund some of these stimulus programs. Ultimately leading to the higher demand from consumers and businesses on the back of that a higher supply of debt. We’ve seen higher rates, but also a little bit of signs of elevated levels of inflation. We may be entering a period of rising interest rates, and that’s a good as well as a bad thing. It’s good because higher rates means higher income. We could all use a little bit more of that, but it’s also bad because yields and bond prices move inversely to one another.

Rates moving up means prices moving down, which can be a drag on your overall return from your fixed income portfolio. Today I would say that between rate and credit risk, I see interest rate risk as being the bigger risk over the next few quarters. Managing the duration of your fixed income portfolio is really going to be critical when you’re seeking to earn income as an objective. The question leads us to where we can find good risk-adjusted yield in today’s market. And to start, I would not look to the Bloomberg U.S. Bond Aggregate where you get a yield of 1.6% while taking on almost seven years of interest rate risk. The highest yielding component in Bloomberg GAG is the U.S. investment grade corporate credit index. And that gets you roughly 60 basis points, more yield than the overall Bloomberg Aggregate.

The IG corporate credit index gets you a 2.2% yield to maturity as of month-end September 30th. And those yields come with a relatively high level of duration. It’s not a very attractive reward to risk setup that we have there. And we’ve seen as a result of that thus far this year with the low to negative returns that we’ve had on the Barclays, I guess, as the treasury yields have risen over the course of 2021. So not a very attractive proposition for those who are seeking to capture income. And instead at DoubleLine, we choose to look outside of these traditional sectors of the fixed income market, outside of treasuries, outside of agency mortgage-backed securities, and outside of investment-grade corporate credit and step out into what we call the non-traditional sectors when looking to deliver yield as an objective. For example, today, investors can look at the areas that we’re participating in. We look to the investment-grade, ABS market, ABS stands for Asset-backed securities, and those generally offer a 1% pickup in yield over IG corporate credit. We’re looking at a yield of maturity of around 3.3% or so, currently. And also, if you want to stay investment grade, you can go down to triple-B CLOs and triple-B CMBS indices. Those have yields of well over 4% today on the yield of maturity basis, and they’re still investment grade. Of course, you can go a little bit lower there as well, as long as you’re able to do your credit work and dip into the below investment grade in those spaces there and get even more attractive yields. As long as again, the key is making sure that you’re getting paid for the risk that you’re taking.

And if you can take some international exposure within your portfolios, if the guidance allows there, then you’ll also find yields in excess of 4% in parts of the Emerging Market Debt. And again, if you can go into it, the opportunities have really opened up there, but if you look at the corporate credit side, USI yields can get you to a yield over the 4% mark, bank loans get you pretty close. They have a yield of just over three and a half percent, somewhere around 3.7%, let’s call it. But those are attractive, especially given it’s a low duration profile based on its floating rate nature. And then, of course, you can find attractive yields in below-investment-grade rated securities in other areas of securitized credit. So anything in the aforementioned CLOs and CMBS, but also more non-agency. Those are the non-government guaranteed mortgage-backed securities, as well as other areas of AVS. But again, we particularly like CLO in bank loans today because they are floating rate. If the short end of the curve starts to move up, then these should benefit from and participate in that in a positive way.