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The Impact of Energy Prices on High-Yield Bond Funds

Positioning within the high-yield energy sector will differentiate managers in 2015.

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In the years coming out of the credit crisis, high-yield bonds were hard to beat. As global credit markets recovered and the U.S. economy enjoyed a period of steady, if moderate, growth, the high-yield Morningstar Category earned an annualized 16% return between 2009 and 2013. Default rates fell sharply after 2009 and remained low; with the exception of a brief stretch in 2011, funds that took the most credit risk ranked among the category's top performers. Many expected more of the same in 2014 with managers citing relatively solid credit metrics and a generally supportive economic environment. However, 2014 had a surprise in store. Energy prices started to tumble in July and had fallen about 50% from their June peak by the end of the year.

Few asset classes have been as directly affected by the energy market as high-yield bonds. High-yield bond funds returned a paltry 1.1% on average in 2014, the category's worst year since 2008, thanks to a rough second half. As shown in the table below, most high-yield bond funds declined in the second half of 2014, wiping out gains from the earlier part of the year. Interestingly, while BB rated bonds generally held up better than lower-quality fare in 2014--not surprising given that these bonds have stronger credit metrics and are also more sensitive to changes in broad market bond yields, which fell during the year--there was a wide dispersion of returns by sector, with energy sharply lagging the rest of the market. The category declined 3.6% during the last six months of 2014, with a 13% decline in the high-yield energy sector driving losses.

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