One of DIA’s core investment philosophies is that the stock market is not necessarily the best option to achieve long term growth evidenced by the fact that in the past 16 years (from 1/1/2000 to 9/30/2015) the market has achieved a paltry 3.7% annual return – far from 8%+ that many investors expect of stocks. Yes, over much longer periods of times returns are in the 8%-10% range but 16 years is long enough to convince us that the stock market gains of the 1980s and 1990s may not be in our future. This does not mean that investors should avoid stocks and we continue to allocate long-term focused client accounts to stocks, but other asset classes should be considered more than many standard allocations recommend. The asset class that we believe offers the best chance to earn a mid-to-high single digit return is high yield bonds. These bonds carry more risk than government bonds or high grade corporate bonds, but these less risky bonds offer only 1%-3% yields versus 6%-8% from the typical high yield bond. How have high yield bonds performed over time compared to the stock market? The chart below compares annualized stock market and high yield bond returns since 1/1/2000, or nearly 16 years:
- Since 1/1/2000, or nearly 16 years, High Yield bonds have returned 6.8% annually versus 3.7% for stocks, nearly double. High Yield bonds have done so with about 1/3 less risk.
- Stocks have experienced much sharper declines than High Yield, with a 12% drop in 2001, 22% in 2002, and 37% in 2008. High Yield has seen only one major plunge, 26% in 2008.
- The 2007-2010 period showed the resiliency of High Yield compared to stocks. While High Yield did plunge in 2008 along with most asset classes, it recovered quickly in 2009 and easily surpassed 2007 levels in less than two years. Stock took much longer to recover, only exceeding 2007 levels in 2012.
Why has High Yield been less volatile, offering more consistent returns? Because bonds have two major advantages: contractual interest payments and a maturity date. The maturity date assures investors that they will get their money back on a fixed date (barring bankruptcy by the borrower) and interest income that is earned daily tempers declines in the market value of the bonds. The incredible yields available in bonds in 2008 brought in many buyers, while stocks took longer to recover since they offered no guaranteed interest or promise to pay back at maturity.
The recent decline in High Yield has resulted in the effective yield of these bonds to rise to 7.6% today, its highest level since 2012. The chart below shows the yield for High Yield bonds since 2011. Historically, when the yields reach these levels, the following average one-year total return has averaged 17.5%.