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These Tamer High-Yield Bond Funds Are Worth a Look

Short-duration high-yield funds are a less risky way to boost income and get protection from rising rates than most in the broader category.

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With rates at historic lows and compressed credit spreads at the top of many investors' minds, short-duration high-yield bond strategies can be an attractive way to supplement income while limiting interest-rate risk and some of the credit risk found in traditional high-yield funds. While definitions can vary, these strategies focus on high-yield bonds with a maturity of one to five years (these represent roughly 30% to 40% of the broader universe) or a duration (a measure of interest-rate sensitivity) of zero to three years. This group of funds represents a fairly small subset of the high-yield bond Morningstar Category (approximately 25 distinct offerings).

As of September 2021, the subset of short-duration strategies in the high-yield bond category offered an average SEC yield of 2.7%. While lower than the broader category's average SEC yield of 3.4%, this was still significant in comparison to the intermediate core bond category's average yield of 1.2%. In this low-yielding environment, these strategies can offer an enticing yield boost while providing insulation against rising rates. But like with all funds, it's important to look under the hood to fully understand the risks.

Given their shorter durations, this subset of high-yield bond strategies typically does better than the broader category during interest-rate spikes. When rates rose over the first 10 months of 2018, the typical short-duration high-yield offering returned 2.0%, outpacing its broader category's median return of 0.4%. More recently, when rates spiked in the first quarter of 2021, short-duration offerings posted a typical return of 1.7%, 75 basis points better than the group norm.

Short-duration high-yield funds also typically take on less credit risk than traditional high-yield strategies. As of June 2021, the typical short-duration high-yield offering held 5 percentage points more in BB rated debt, which is the highest rating for junk-rated debt, than the high-yield category norm. The typical short-duration high-yield fund also held 15 percentage points less in debt rated B and below than the high-yield category median. That posture typically results in less severe losses during rocky periods for credit. When high-yield debt wobbled in the fourth quarter of 2018, the typical short-duration junk-debt-focused offering slid 175 basis points less than the broader category. More recently, when the coronavirus shook markets in 2020 between Feb. 20 and March 23, the short-duration high-yield peer group's median decline was 16.9%, while the high-yield category norm was a 21.0% plunge.

Here are two short-duration high-yield strategies that stand out given their thorough approach to picking credits and sizable resources. 

Shenkman Capital Short Duration High Income (SCFIX), which has a Morningstar Analyst Rating of Bronze, represents a solid choice in this space. Shenkman Capital focuses exclusively on leveraged finance and boasts a deep team. Five long-tenured comanagers run this strategy with support from more than 20 credit analysts, six traders, and a six-person risk team. The team employs a rigorous credit-review process and tilts the strategy toward less-leveraged and more-liquid securities. From its November 2012 inception through August 2021, the strategy's conservative posture left its 3.5% annualized return trailing the broader high-yield category and even most short-duration high-yield peers. However, its risk-adjusted return, as measured by the Sharpe ratio, ranked among the best in both peer groups over the same period given its more muted losses in tougher markets.

Silver-rated PGIM Short Duration High Yield Income (HYSZX) is another strong option. The strategy is implemented by five U.S.-focused high-yield managers and roughly 30 leveraged-finance analysts. The strategy employs a rigorous methodology, including a well-defined system for sizing issuer exposures. Management keeps its duration at less than three years, its average maturity less than five years, and CCC rated debt below 10%. The strategy has delivered strong performance over time: From its November 2012 inception through August 2021, its 4.9% annualized return bested all its distinct short-duration high-yield peers. While that return lagged the broader category over the same period, its Sharpe ratio landed in the category's best quartile.

All told, short-duration high-yield strategies offer a less volatile way to boost yield while limiting exposure to rising rates. That said, while these offerings are typically more conservative than most high-yield funds, investors should still look under the hood when picking one as some can carry additional risk. Things to watch out for include small research teams, concentrated portfolios, ample derivatives use to lower duration, and elevated stakes in lower-rated credits or smaller, less-liquid deals.

Sam Kulahan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.