A flurry of events sent the market floundering last year—the Russia-Ukraine war, Federal Reserve tightening, rising inflation, and soaring energy prices. Name anything that transpired in 2022, and it probably had a ruinous air. What was anticipated to be an occasional shower turned out to be a severe rainstorm, and practically no asset class was spared. High-yield bonds didn’t escape, losing almost 11% because of worries about a recession but also because of rising interest rates. Investors responded by taking a record $52.8 billion out in the first three quarters of 2022.
The good news is this selloff boosted yields, and it could be a buying opportunity. The current yield level of roughly 9% offers an attractive entry point from an income perspective. Certainly, risks lurk, but with disciplined and judicious credit selection, so do opportunities. Here is a lineup of funds we have favored for the active managers’ ability to discern dislocations and drown out the noise.
One of the most aggressive funds in the high-yield bond Morningstar Category is Fidelity Capital & Income FAGIX, which has a Morningstar Analyst Rating of Bronze. Its managers have at times assumed considerable risks but also exercised well-warranted caution. Their edginess shows through its lofty CCC stakes and large equity holdings (up to 20% of assets), but they also play defense by holding plenty of dry powder and boosting investment-grade debt during a challenging macroeconomic backdrop.
The managers’ bold taste leads to a bust-or-boom profile, and there’s no denying that losses can be punishing. But those who have stuck with the fund have been well-rewarded: Its 7.0% annualized return over the trailing 15 years through December 2022 bested all category peers.
Silver-rated BlackRock High Yield Bond’s BHYAX versatile approach means the managers aren’t bound by specific credit rungs, and that gives them the freedom to go wherever they find the most attractive relative value. The managers invest mainly in the high-yield bond market’s larger, more liquid issues, but the fund’s broad purview also allows them to invest in diverse asset classes and gain exposure to various market segments through equity (up to 10%), bank loans, exchange-traded funds, and swaps.
Such broad license under less experienced hands may prove disastrous, but the seasoned managers have adroitly navigated BlackRock High Yield Bond despite its behemoth size. Over the trailing 15 years through December 2022, the strategy’s 6.0% annualized return landed it in the top decile of the category.
Unlike the aforementioned funds, Bronze-rated Pimco High Yield PHDAX focuses on the higher-quality end of the high-yield credit spectrum and holds mostly BB- and B rated debt with only a sprinkling of CCC rated debt. That and a general avoidance of equity lend the fund a more cautious profile. It can be a suitable option for those with a milder risk palate as it tends to protect during credit downturns, as it did in 2020′s first quarter when it beat almost two thirds of its category peers. Its 2022 performance was middling, however, owing to its holdings’ negative response to the past year’s rate volatility.
Still, the fund’s 10.8% loss for the year was in line with the typical peer’s 10.7% loss, and over the trailing 15 years, its 5.1% annualized return was in line with about half of category peers. Moreover, with an analyst team that’s easily twice as big as those at Fidelity or BlackRock, Pimco’s robust setup boosts its appeal.
A version of this article was published in the December 2022 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting the website.