Yield Chasers Left Behind As Treasuries Beat Both Investment Grade and Junk Bonds

Daniel Drew, 3/26/2017

Maybe I missed a few things slouched in the back row of finance class years ago, but one thing I remember clearly: the prof said more risk would lead to higher rewards. Or maybe he said potential rewards. As my career in finance unfolded, I witnessed countless investors seeking these potential rewards by selecting what I call "discount dynamite." It's dynamite that is on sale because the fuse is shorter than usual. Inevitably, these deep discounters quickly discover there is a very good reason why the fuse should be a minimum length.

You've probably seen it before. "Emerging market bonds," a.k.a. banana-backed securities from Guatemala, Venezuelan bonds that aren't worth the paper they're printed on, and Nigerian fixed income, which includes an embossed certificate signed by the local prince. Some of these funds are yielding 13%. You used to have to lie to get investors to buy junk, but now, you just call it JNK, and it grows into a $10 billion fund.

The old argument says that as long as you diversify enough, junk can actually give you high risk-adjusted returns. Higher risk, higher rewards. Finance 101.

A look back at the last 10 years shows that chasing yield leaves investors running in circles. I compared JNK, LQD, and TLT total returns. These are "high yield" bonds, investment grade bonds, and treasuries. The study begins December 7, 2007 (JNK inception date). Here are the results:

JNK: 36.9%

LQD: 54.7%

TLT: 67.4%

The "highest yielding" asset had the lowest return, and the least risky asset had the highest return. This represents the complete implosion of a core principle in modern finance. Perhaps we are just returning to an earlier time in 1848, when selling shovels was more profitable than chasing gold.

So the next time you buy a stock that tanked 20% because "it has a good dividend," consider another high yield alternative: Nigerian bonds transacted over Moneygram.