One of the toughest debates on Wall Street today is whether investing in high-yielding "junk" bonds — the riskiest type of credit — is a smart move, or a dangerous gamble to be avoided at all costs.
Katie Nixon, who oversees $300 billion in wealth as the chief investment officer of Northern Trust Wealth Management, says she's emphatically in the former camp.
"We have persistently been very positive on high-yield," she told Business Insider in an exclusive interview. "You hear a lot of negative stuff about high-yield now, but you look at the pricing in the market and there's certainly nothing that would suggest there's any problem."
High-yield debt is issued by the companies with the worst credit, meaning that if their situation deteriorates because of weakening business or a downturn in the economy, they could fail to repay their bonds. Because of the challenges they face, the companies issue high yielding debt precisely to get investors to take the risk of backing them.
In the wake of a 10-year bull market for stocks and a 30-year run for bonds, Nixon argues that investors are looking at significantly weaker returns in the years ahead. Over the next five years she expects US stocks to rise less than 6% annually, while returns from bonds will stall out at about 3%.
That means the extra income investors can get from high yield could be critical — far more than it seems today, with the S&P 500 index up 24% year to date.
"We're talking about low returns across multiple asset classes," she said. "A third of the return of US assets over the next five years could come from dividends."
A lot of professionals are telling their clients to stay away from this part of the market because they think it adds so much risk to their portfolios, particularly with the long-lived economic expansion in its tenth year. But Nixon offers two counterarguments.
The first is that the corporate defaults are actually decreasing, and the risk that frightens so many people is mostly confined the companies with the very lowest credit ratings of CCC or lower.
"A lot of what gets bad press in the high yield market are the deeply distressed CCCs, where you've got a lot of really distressed energy companies, media, telecom, retail," she said. "With an actively-managed high yield portfolio you can sort of avoid the really junky junk and still get paid a reasonable return for what I think what appears to be a modest amount of risk."
Her other argument is that there are a lot of fundamental similarities between high yield bonds and stocks, as they're both risk assets that are relatively sensitive to the health of the economy. Since most experts are at least neutral on stocks, that implies a good backdrop for high yield bonds as well.
"High-yield is sort of the lowest lowest risk equity out there. It's going to act like an equity with a lower beta," she said.
For all the scrutiny of high-yield bonds, she adds, investors to this point haven't uncovered any real signs of danger.
"High yield has gotten a little bit of negative press recently, but it's mostly been in the leveraged loan market," she said. "High yield spreads are still pretty tight, so the market is not discounting any trouble in the high yield bond market."