Calvert News & Commentary

Yield Capture: A Short-Duration/High-Yield Approach

7/24/2014

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Combining short-duration1 and high-yield bonds is a strategy that may help overcome Thincome in today's low-yield environment.

As money-market and CD rates remain near historic lows, many investors continue to be challenged in their quest for income, a situation we refer to as "Thincome." Complicating this scenario is the heavy issuance of new bonds in recent years with record-low coupons (or interest rates). The majority of bond durations are relatively longer as well, creating the potential for greater price volatility.

One option for meeting this challenge may be through investing in a strategic blend of short-duration and high-yield bonds, allowing an investor to potentially add yield while controlling risk. This approach can be used as a stand-alone strategy or as a full or partial substitution for an existing intermediate-bond allocation. For the three years ended 12/31/13, strategic blends compared favorably to a broad, intermediate-term bond allocation, offering:

  • Higher yields than the intermediate Barclays Aggregate Index yield of 2.23%.
  • Higher annualized returns.
  • Higher annualized standard deviation2 (risk), but significantly less than that of a pure high-yield allocation

Blends may offer yield and return advantages over intermediate-term bonds

Yield, Return, and Standard Deviation Comparison for the 36-month period ended 12/31/2013

A blend of short-duration and high-yield bonds has provided better returns and higher yields than intermediate-term bonds over the past three years, albeit with added risk. Short-duration bonds are represented by the Barclays 1-5 Year U.S.Credit Index, intermediate bonds by the Barclays Aggregate Index, and high-yield bonds by the BoA Merrill Lynch High Yield Master II Index.

Indices are unmanaged and do not reflect the payment of advisory fees and other expenses associated with an investment in a mutual fund. It is not possible to invest directly in an index. This chart is for illustrative purposes only and is not inidicative of any cactual investment. Past performance does not guarantee future results. Source: Zephyr and Calvert Investments, Inc.

A Strategy for All Seasons

The results cited earlier for the short-duration, high-yield blends occurred during a time of deep challenges to the global markets. Going forward, as the U.S. economy strengthens and the eurozone stabilizes, this strategy may be poised to "ride the economic recovery." A high-yield component may provide a pick-up in yield and total return, while exposure to shorter-duration securities could potentially reduce portfolio price volatility if interest rates rise. In addition, since high-yield bonds have been negatively correlated3 to Treasuries in recent years, they may also provide a measure of portfolio diversification and stability.

The 10-year Treasury note duration is about 10% higher than its average over the last decade—while yields are lower—translating to greater interest-rate risk. Source: Calvert Investments, Inc.

Why Short-Duration Bonds

Short-duration bonds have less exposure to interest-rate risk and can help mitigate portfolio losses as rates rise from their historic lows. Although a significant increase in interest rates appears unlikely in the near term, a short-duration bond allocation may be a prudent risk-management measure.

Short-duration bond funds offer the potential for:

  • Principal preservation
  • Management of interest-rate risk
  • Total return
  • Diversification

Why High-Yield Bonds

High-yield bonds are generally more volatile than most other fixed-income investments and pay higher rates of interest to compensate for that risk. High-yield bond prices tend to do well when a recovery is on the horizon and stumble in a weakening economy. Currently, these issuers have strong balance sheets and cash positions.

Market trends still favor high-yield bonds:

  • Strong investor demand for yield
  • Yields are relatively high compared to other fixed-income assets
  • Low forecast default rate of about 3%

Keep Risks in Mind

Investments in high-yield bonds can involve a substantial risk of loss. High-yield bonds are considered to be speculative with regard to the issuer's ability to pay interest and principal. These securities, which are rated below investment grade, have a higher risk of issuer default, are subject to greater price volatility, and may be illiquid. High-yield and short-duration bonds are subject to credit risk and interest-rate risk, the risk that changes in interest rates will adversely affect the value of an investor's securities. When interest rates rise, the value of fixed-income securities will generally fall.

Calvert offers the Calvert Short-Duration Income Fund (CSDAX) and Calvert High Yield Bond Fund (CYBAX). The index-based performance depicted is not indicative of an investment in these or other Calvert funds.

1. Duration measures a portfolio's sensitivity to changes in interest rates. Generally, the longer the duration, the greater the change in value in response to a given change in interest rates.
2. Risk is measured by the standard deviation, or volatility, of an index's return. A standard deviation of "1" means an index can be expected to produce an annual return that is plus or minus 1% of its average annual return 68% of the time. Standard deviation is one measure of portfolio risk.
3. Correlation indicates how closely the returns of different investments track each other. Values range from -1.00 to 1.00, with 1.00 indicating perfect positive correlation. The lower the correlation, the higher the diversification potential.


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Calvert Investment Management, Inc. serves as the investment advisor and provides sustainability research for the Calvert mutual funds and institutional investment strategies.

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