High-yield bond investors who adopt an environmental, social, and governance (ESG) discipline must consider the potential impact on returns. Recently introduced high-yield benchmarks for ESG-conscious portfolios make it possible to quantify these effects. ESG-based high-yield indexes produced higher historical returns than a standard high-index, but those differences are not statistically significant. The apparently superior downside protection provided by ESG-oriented funds in down markets is explained by two major confounding factors: the ESG-based indexes’ underweighting in Energy bonds and lowest-rated issues. High-yield investors cannot reliably cushion their returns during sell-offs by avoiding issuers involved in controversial weapons or with poor scores in other ESG categories. Energy companies with good ESG scores show no tendency to provide or to not provide superior downside protection in a high-yield bear market. The overall evidence to date on relative performance confirms neither a bonus nor a penalty for adhering to ESG principles within a high-yield portfolio. The growth of investing with attention to ESG factors has generated considerable controversy. Both proponents and critics are keen to answer this question: Must ESG-conscious investors sacrifice return for the sake of their principles, or do good ESG corporate citizens achieve higher profits with less risk, and actually outperform standard indexes? The authors address this question by comparing the returns of recently introduced ESG high-yield indexes and a standard index of the asset class. TOPICS:Fixed income and structured finance, ESG investing, mutual funds/passive investing/indexing, performance measurement Key Findings ▪ Recently introduced high-yield benchmarks for ESG-conscious portfolios make it possible to quantify the performance impact of adopting an ESG discipline. ▪ ESG-based high-yield indexes produced higher historical returns than a standard high-yield index, but the differences are not statistically significant. ▪ The apparently superior downside protection provided by ESG-oriented funds in down markets is explained by two major confounding factors. ESG-based high-yield indexes are underweighted in energy bonds and lowest-rated issues.

In telling his story, Asensio, a short seller and founder of Asensio and Company, provides valuable insight into the proactive approaches of those who buy long and those who sell short.

In this book (reviewed with The Investoru0027s Guide to Economic Fundamentals), a staunch supporter of the so-called New Economy maintains that the economic transformations responsible for it are real,...

Past comparisons of "market ratings," or yield spreads over Treasury rates, and letter grades published by credit rating agencies have focused on the two indicators' respective records in predicting defaults or promptness in reflecting company-specific changes in credit quality. Corporate bond managers who mark to market and are evaluated on the basis of their annual total return, however, care greatly about price sensitivity to market-wide changes in credit risk premiums. Empirical evidence presented in this study indicates that market ratings provide better information on that matter than agency ratings.

The credit spread curve is the difference in spread-versus-Treasuries between long-maturity and short-maturity issues. Two articles published in the 1990s reached opposite conclusions regarding whether the slope of that curve is positive or negative. The authors find that neither study uncovered the essential point that the curve is negatively sloped in most periods but positively sloped in periods of exceptionally low perceived credit risk. The true explanation of the shape of the credit spread curve lies in the shift in valuation metric from spread-versus-Treasuries to price as a percentage of face value as default risk increases. TOPICS:Fixed income and structured finance, statistical methods, credit risk management

This Research Foundation brief explores various dimensions of the high-yield bond market. One contributor decomposes returns and relates risk and associated risk premiums via an econometric fair value model. Another illustrates principles of credit analysis via a case study involving a debt-financed merger. A third analytical piece focuses on forecasting the default rate. Two remaining contributions are primers — one on the corporate bankruptcy process and the other on high-yield bond covenants. The final section presents analyzes high-yield price histories as a function of macroeconomic forces, impulse forces, risk, and technical features of the time series themselves.

Almost 20 years ago, one of the coauthors of this article published a study that reported finding systematically wider yield spreads on senior corporate bonds than on subordinated bonds with the same credit rating, but issued by different companies. The study also showed that this difference in spreads did not represent a market “anomaly” or failure to price risk correctly, but instead reflected differences in the actual, and hence the expected, loss rates of the securities. And such differences were in turn shown to stem from the practice of the rating agencies—which was abandoned about ten years ago—of rating a given issuer's subordinated debt two “notches” below that of its senior debt. Partly in response to this finding, all of the major agencies modified their use of this “two‐notch” convention by initiating in‐depth fundamental analysis of subordinated issuers on a case‐by‐case basis.In the meantime, the near disappearance of subordinated debt in the high yield market since the global financial crisis and its partial replacement by secured debt has furnished the authors of this article with a seemingly related “anomaly” to explore—namely, the tendency of secured bonds to have higher yields than samerated senior unsecured bonds. As in the earlier study of the senior‐subordinated puzzle, the authors' analysis confirms that the market has been properly pricing the relative risks of the different securities by showing that the actual loss rates of the secured issues have been systematically higher than those of like‐rated senior unsecured issues. The clear suggestion of these findings, as in the case of the earlier study, is that those investors who have chosen to incur the costs of analyzing expected loss rates instead of relying solely on the ratings have been rewarded for their efforts. And if the past is a guide to the future, this article may also succeed in spurring the rating agencies to make further refinements to their methods.

Over time, the annualized return of a duration-targeting, investment-grade corporate bond portfolio will nearly match its initial yield. A high-yield bond portfolio's performance is not similarly predictable. Furthermore, the difference between the high-yield universe's initial yield and annualized return has a sharply negative bias. The absence of benefits from duration targeting has a bearing on valuation of the highyield asset class and helps explain the instability in its investor base.

article reviews the book The Clash of the Cultures: Investment vs. Speculation by John C. Bogle.

Sector rotation strategies are gaining fans among the ranks of portfolio managers, with some relying on valuation as key to predicting the best-performing sector. However, little of the research has considered the impact o using valuation as a selection criterion. In Is There Value in Valuation? , which was published in the Winter 2013 issue of The Journal of Portfolio Management , the authors find that applying a robust valuation model to ratings groups of high-yield bonds does not definitively add value in sector rotation portfolios. In this Practical Applications report, Co-Authors Martin Fridson, Chief Executive Officer of FridsonVision LLC, and John D. Finnerty, Professor of Finance at Fordham University, recommend investors in other asset classes adapt their model to test whether a “rich and cheap” sector rotation valuation strategy adds to total return. The article has been gaining attention in the broader media. Most recently, www.CBSNews.com picked it up: Can you Profit From Valuation?

It seems self-evident to many investors that valuation is the key to picking winners in a sector-rotation strategy. The authors' analysis of quality tiers within the high-yield bond market casts doubt on that premise. The market's direction exerts such a big influence on relative returns that limited room remains for valuation to have an impact. In light of the authors' findings in the speculative-grade debt market, value-oriented investors in other asset categories may also need to rethink their assumptions.

Currently, it is hard to make a case that a bubble exists in high-yield bonds. The high-yield market, regardless of its many challenges, offers relative-value opportunities for investors, but prudence and thorough analysis are paramount.