Risk versus return. It’s what investing is all about. Balancing the potential for losses and volatility with how much potential return is arguably the main tenet of portfolio construction. It’s why modern portfolio theory and asset allocation exist in the first place. Overall, finding a balance is what provides investors with a good night’s sleep versus a restless evening.
And one asset class could allow investors to have their cake and eat it too.
Short-term high-yield bonds could be a great asset class for portfolios. Offering higher yields than long-term junk bonds and stock-like returns, with lower volatility and drawdowns compared to equities, and minimal interest rate risk, the asset class could be the answer to finding needed returns amid lowered risk. For investors- both fixed income and equity seekers- the asset class has a lot to offer portfolios.
The Short Side Of Junk
As an asset class, high-yield or junk bonds have long been used by investors to boost their portfolio’s yield, provide equity-like returns, and enhance risk-reward profiles. Often, this means adding a broad active or passive high-yield bond fund or strategy to a core fixed income portfolio.
But instead of thinking broadly and owning the entire high-yield market, maybe they should be thinking about the short end of the junk bond curve.
As the name implies, short-term high-yield bonds are bonds that feature less than investment-grade credit ratings, rated BB or lower by Standard & Poor’s and Ba or lower by Moody’s. And like regular junk bonds, short-term bonds pay higher coupons given the potential default risks of the issuing firms.
The short-term nature refers to how close are these bonds to their maturity dates. Typically, less than three years away. Bonds within this category get there one of two ways. They can be initially issued with short maturities of less than three years, or they can be longer-term bonds that only have a few years or months left before they mature.
Benefits Of Going Short
So why go short? Why focus on the closer maturity side of the equation? Well, it turns out that this side of junk bonds can pay plenty of benefits for both equity and fixed income investors.
For starters, there’s yields to consider.
During normal times, short-term junk bonds pay some very strong yields relative to investment-grade bonds and their longer-term high-yield siblings. But these aren’t normal times. Thanks to unusual market conditions, a flattening yield curve, and other factors, short-term junk bonds are currently paying more than long-dated junk securities. According to AllianceBernstein, investors looking at yields for junk bonds maturing in the next five years can score yields close to 9%. However, moving beyond that point, the yields begin to dip as low as 7.00%. 1
Those high yields — in both normal times and today — plus the short-term maturities of these bonds make for a powerful combination.
Earning 8% in yield is a very equity-like return. The benefit is that short-term junk bonds have managed to produce that equity-like return with far less volatility and dispersion than actual stocks.
Since 2000, equities and junk bonds have exhibited similar return profiles on rolling five-year periods. The key is that short-term junk has had lower drawdowns during this time. This chart from AllianceBernstein shows that short-term junk bonds have had lower average losses than stocks or the broader high-yield market during sell-offs. In the case of equities, stocks have averaged more than triple the losses of short-term junk.
Source: AllianceBernstein
With short-term high-yield bonds, investors can essentially get equity “exposure” without the volatility and loss potential, providing a balance of risk vs. reward.
The key to the drawdown and losses is the short-term maturity profile. It stands to reason that a bond maturing in a month or year has less default risk than, say, one maturing in five years. The odds of a firm not making its final payment are pretty slim. But over the next five years? Who knows!
Data supports this fact. Default rates for BB- and B-rated bonds are just 0.29% and 1.14%, respectively, over one year. This is versus 3.71% and 13.47% over five years. Additionally, the lower volatility of short-term junk can also be attributed to what’s known as “pull-to-par.” As a bond approaches its maturity and default risk becomes increasingly negligible, the price of a bond will move closer to its par value. For a government-issued treasury bond, pull-to-par doesn’t typically occur outside of 20- or 30-year bonds. But for the high-yield market, where most bonds trade at significant discounts to their par values, the phenomenon is pervasive.
Then there is the interest rate to consider. Overall, short-term bonds generally have lower durations than longer-term bonds. Short-term junk is no different. This allows them to move less in terms of interest rate policy changes. Again, reducing drawdowns and volatility of the asset class.
Short-Term Junk Is A Smart Allocation
Short-term high-yield bonds can produce strong equity-like returns without as much risk as stocks or even the broader high-yield market. And with yields today in excess of long-term bonds, the choice to go short is clear. By allocating them to a dedicated portfolio, investors can reduce their drawdowns, collect substantial distributions, and enhance portfolio performance.
The best part is that the high-yield bond market is full of potential portfolio choices. Today, both active and passive funds exist targeting these bonds. Adding them and making them a dedicated sleeve of a portfolio is a snap.
Short-Term Junk Bond ETFs
These funds were selected based on their allocations to short-term junk bonds. They are sorted by their YTD total returns, which range from -0.8% to 3.6%. They have expense ratios between 0.30% and 1% and have assets under management between $27M to $6.5B. They are currently yielding between 2.4% and 7.6%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| HYS | PIMCO 0-5 Year High Yield Corporate Bond Index ETF | $1.45B | 3.6% | 7.4% | 0.57% | ETF | No |
| FHYS | Federated Hermes Short Duration High Yield ETF | $27M | 3.3% | 6.3% | 0.51% | ETF | No |
| IBHG | iShares iBonds 2027 Term High Yield and Income ETF | $263M | 3.2% | 6.8% | 0.35% | ETF | No |
| SHYG | iShares 0-5 Year High Yield Corporate Bond ETF | $6.5B | 2.9% | 7% | 0.30% | ETF | No |
| SJNK | SPDR Bloomberg Short Term High Yield Bond ETF | $5B | 2.6% | 7.6% | 0.40% | ETF | No |
| SJB | ProShares Short High Yield | $54M | -0.8% | 2.4% | 1% | ETF | No |
Overall, short-term junk bonds offer an innovative and compelling choice today. They can provide a way to reduce volatility while still getting an equity-like return for a portfolio. For both fixed-income seekers and stock investors, the asset classes’ high yields and lower drawdowns make a great deal of sense.
Bottom Line
Balancing risk and reward is tough. But short-term high-yield bonds could be the answer. Thanks to their high yields and short-term maturity profiles, they can offer strong returns without interest rate risk and provide lower drawdowns than equities. Suing them as a dedicated sleeve in a portfolio is a good portfolio bet.
1 AllianceBernstein (May 2025). High-Yield Bonds: Why Shorter May Be Smarter
