IN FOCUS6-8 min read

How to cope with rock bottom corporate bond yields?



Sean Markowicz, CFA
Strategist, Strategic Research Group

The yield on US investment grade (IG) corporate debt recently fell below 2% for the first time ever, as expectations seep in of a persistently low interest rate and inflationary environment.

Against this backdrop, investors face a tough road ahead. They can settle for paltry yields or ride up the risk spectrum to make up for the shortfall in returns.

However, those that choose the latter should tread carefully. Such an approach is likely to suffer the most during economic downturns.

Selective risk-taking and rigorous analysis of company fundamentals are essential to generating a satisfactory income without compromising on quality.

Why have yields tumbled?

The yield on a corporate bond is made up of two components – a base interest rate and a credit spread. The interest rate is equal to the yield on a government bond with a similar maturity, which is considered to be risk-free. The credit spread reflects the extra compensation investors receive for bearing default risk, which is inversely related to the credit worthiness of the corporate. 

In March, the US Federal Reserve launched a massive stimulus programme by purchasing large swaths of government and corporate debt. This provided much-needed liquidity and support to the market amidst the turmoil generating by the coronavirus. In response, interest rates cascaded to record lows, which dragged down yields on corporate bonds. Meanwhile, although credit spreads have come down as well, they still remain above pre-crisis levels.

What effect have lower yields had on bond characteristics?

One consequence of lower yields is increasing duration. Duration is a measure of a bond’s price sensitivity towards interest rate movements. For example, before 2008, a 0.5% rise in yields would have resulted in corporate bond prices falling by 3.1%. Yet today, it would result in a loss of 4.2%. When coupled with the fact that yields are much lower to start with, it would take very little movement in bond yields to leave investors nursing losses.

But don’t worry, there’s hope

Investors can reduce their interest rate sensitivity by shortening the duration of their portfolio. The opportunity cost of this trade would be the forgone income from investing in higher-yielding, long duration bonds.

However, it’s important to remind investors that not all corporate bonds lie neatly along a curve. In fact, there is a broad spectrum of income opportunities available for a given level of duration, or alternatively a fixed income available for a lower duration.

For example, investors can earn a yield of 2% with a duration of 8.5 years at the US IG index level, but there are many other bonds available that achieve the same level of yield with less interest rate sensitivity.

Some of this yield pick-up will reflect the market’s dimmer view of these companies’ prospects or because those companies have a lower credit rating, but not always. Bonds with relatively lower liquidity or a smaller issue size can also make a bond less attractive to some investors and result in a higher yield without a commensurate increase in credit risk. When we repeat the analysis for individual credit ratings, there remains significant dispersion.

Fundamental research is key to identifying mispriced bonds and avoiding those that turn out to be cheap for good reason. A selective approach, within a highly diversified portfolio, can take advantage of the full range of income options and potentially generate a more satisfactory outcome for investors.

Important Information

The contents of this document may not be reproduced or distributed in any manner without prior permission.

This document is intended to be for information purposes only and it is not intended as promotional material in any respect nor is it to be construed as any solicitation and offering to buy or sell any investment products. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Any security(ies) mentioned above is for illustrative purpose only, not a recommendation to invest or divest. Opinions stated are valid as of the date of this document and are subject to change without notice. Information herein and information from third party are believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.

Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Derivatives carry a high degree of risk. Exchange rate changes may cause the value of the overseas investments to rise or fall. If investment returns are not denominated in HKD/USD, US/HK dollar-based investors are exposed to exchange rate fluctuations. Please refer to the relevant offering document including the risk factors for further details.

This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.


Sean Markowicz, CFA
Strategist, Strategic Research Group


In Focus
Fixed Income
Follow us

Contact Us

Level 33, Two Pacific Place, 88 Queensway, Hong Kong

(852) 2521 1633

Online enquiry: Please complete the web form below and we will reply as soon as possible.

Contact us

The investments mentioned in this website may not be suitable to all investors. The information contained in this website is provided for reference only and does not constitute any investment advice. Investors are advised to seek independent advice before making any investment decision.

Investment involves risk. Past performance is not indicative of future performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Please refer to the relevant offering document including the risk factors.

This website is intended for Hong Kong residents only. Non-Hong Kong residents are responsible for observing all applicable laws and regulations of their relevant jurisdictions before proceeding to access the information contained herein. Schroder Investment Management (Hong Kong) Limited is regulated by the SFC. The website (excluding Schroder Provident Plan related pages) has not been reviewed by the SFC.

The website is issued by Schroder Investment Management (Hong Kong) Limited.