Diversification Re-Engineered

Swapping CCC rated bonds for convertibles: a smarter route to high yield returns?

Substituting convertibles for CCC rated bonds in high yield mandates may improve return potential while reducing reliance on distressed credit risk.

Key takeaways
  • Convertible bonds combine equity characteristics with bond-like downside support, often leading to historical outperformance versus CCC rated bonds.
  • Lower correlation to higher-quality high yield can diversify return sources beyond traditional credit beta and coupon income.
  • Replacing CCC exposure with convertibles may improve portfolio efficiency, preserving upside while reducing downside.
     

Corporate bonds rated CCC – considered speculative with a significant default risk – have their place, but they typically involve drawbacks. Historically they have offered only modest incremental return relative to higher-quality high yield bonds, while introducing greater volatility, default sensitivity and liquidity risk. The modest return differential is primarily a function of higher coupon income (required to compensate investors for increased risk) minus credit losses from defaults and restructurings. Their increased volatility is primarily the result of higher default risk coupled with less liquidity/ownership.

We believe one option for addressing these drawbacks is to substitute convertible bonds in place of CCC rated paper. Convertibles, which give the investor the option to convert the bond into a predetermined number of shares, combine elements of a bond and a share. In the context of a diversified fixed income portfolio, they have the potential to increase returns while reducing dependence on distressed credits.

Why convertibles offer a different return profile
Looking back over the period from 1997 until May 2026, convertibles have tended to offer higher returns with less volatility than CCC rated bonds (Exhibit 1). Unlike traditional fixed income, their hybrid nature results in an asymmetric return profile. The embedded equity optionality creates participation in issuer upside, while the bond component can help moderate downside relative to lower-quality credit exposure.
Exhibit 1: Convertibles have delivered stronger returns with less volatility than CCC rated bonds
Convertibles have delivered stronger returns with less volatility than CCC rated bonds

Data 1 January 1997 to 31 May 2026. Source: FactSet, ICE Data Services, Voya IM. Past performance is not indicative of future results. This statement reflects performance and characteristics for the time period shown; results over a different time period may have been more or less favourable. US convertibles: ICE BofA US Convertibles Index. US High Yield/BB-B/CCC: ICE BofA US High Yield Index and corresponding subindexes.

Lower correlation to higher-quality high yield

Convertibles may offer diversification benefits within credit oriented portfolios. In the past 20 years, the ICE BofA US Convertible Index has exhibited a lower correlation to higher quality, high yield bonds – represented by the ICE BofA BB-B US High Yield Index – than the lowest quality segment, or CCC rated bonds (Exhibit 2). This relationship reflects differentiated return drivers. While high yield bond performance is largely tied to coupon income, convertible security performance is primarily influenced by the movement of the underlying equity, resulting in more varied sources of return.

This combination can enhance portfolio efficiency by reducing reliance on traditional credit beta. In periods when credit spreads, liquidity and default risk dominate high yield returns, convertibles may serve as a complementary exposure, potentially improving overall portfolio performance across economic cycles.

Exhibit 2: Lower correlations signal greater diversification potential
Lower correlations signal greater diversification potential

Data from 1 June 2006 to 31 May 2026. Source: FactSet, ICE Data Services, Voya IM. High yield/BB/B/CCC bonds: ICE BofA US High Yield Index and corresponding subindexes. Convertible securities: ICE BofA US Convertible Index.

Portfolio efficiency can improve when CCCs are replaced
When viewed through a portfolio construction lens, substituting CCC exposure with convertibles has historically improved the efficiency of a high yield allocation. Since 1997, increasing exposure to convertibles has shifted the efficient frontier upward and to the left, delivering stronger performance for a given level of risk relative to portfolios with concentrations in lower quality high yield (Exhibit 3). By reducing reliance on binary credit outcomes and introducing positive convexity-based return characteristics, convertibles can help improve returns and reduce volatility over time.
Exhibit 3: Replacing CCC exposure with convertibles has improved high yield portfolio efficiency
Replacing CCC exposure with convertibles has improved high yield portfolio efficiency

Data from 1 January 1997 to 31 May 2026. Source: FactSet, ICE Data Services, Voya IM. Past performance is not indicative of future results. This statement reflects performance and characteristics for the time period shown; results over a different time period may have been more or less favourable. Convertibles: ICE BofA US Convertibles Index. BB-B/CCC High Yield: ICE BofA US High Yield (BB-B) Index and CCC & Lower Index.

Market participation with a better asymmetry
Examination of upside and downside capture rates reveals another perspective on these diversification benefits. Exhibit 4 anchors market participation to quarterly returns of the ICE BofA BB-B US High Yield Index and shows that the convertible market’s upside capture is similar to the rate of CCC rated bonds. Studying the declining periods of higher quality high yield bonds, it’s clear the convertible market exhibits notably less downside risk.
Exhibit 4: Convertibles have captured upside with meaningfully less downside than CCC rated bonds

Convertibles have captured upside with meaningfully less downside than CCC rated bonds

1 January 1997 to 31 May 2026. Source: FactSet, ICE Data Services, Voya IM. Past performance is not indicative of future results. This statement reflects performance and characteristics for the time period shown; results over a different time period may have been more or less favourable. Convertibles: ICE BofA US Convertibles Index. BB-B/CCC High Yield: ICE BofA US High Yield (BB-B) Index and CCC & Lower Index.

What investors should consider before reallocating

Convertibles typically offer lower stated coupons than CCC rated bonds, so investors should evaluate the tradeoff between current income and total return potential. Performance may also be influenced by equity-market volatility, issuer-specific equity sensitivity and broader risk-off conditions. In sharp credit recoveries, lower-quality high yield may rebound more quickly, which can create periods of relative underperformance for convertibles.

However, we think that, in general, convertible securities offer a significantly higher return potential, demonstrate lower volatility and provide greater diversification benefits relative to CCC rated bonds. For high yield mandates seeking to reduce exposure to the weakest segment of the credit market, convertibles may offer a more efficient way to retain upside potential while improving diversification and downside resilience.

 
A note about risk 

All investing involves risks of fluctuating prices and uncertainties of rates of return and yield inherent in investing. All security transactions involve substantial risk of loss.

Debt instruments: Debt instruments are subject to greater levels of credit and liquidity risk, may be speculative, and may decline in value due to changes in interest rates or an issuer’s or counterparty’s deterioration or default.

Market volatility: The value of the securities in the portfolio may go up or down in response to the prospects of individual companies and/or general economic conditions. Price changes may be short or long term. Local, regional or global events such as war, acts of terrorism, the spread of infectious illness or other public health issue, recessions, or other events could have a significant impact on the portfolio and its investments, including hampering the ability of the portfolio’s manager(s) to invest the portfolio’s assets as intended.

Issuer risk: The portfolio will be affected by factors specific to the issuers of securities and other instruments in which the portfolio invests, including actual or perceived changes in the financial condition or business prospects of such issuers.

Interest rate risk: The values of debt instruments may rise or fall in response to changes in interest rates, and this risk may be enhanced for securities with longer maturities.

Credit risk: If the issuer of a debt instrument fails to pay interest or principal in a timely manner, or negative perceptions exist in the market of the issuer’s ability to make such payments, the price of the security may decline. Index information

Investors cannot invest directly in an index. Index returns are presented as net returns, which reflect both price performance and income from dividend payments, if any, but do not reflect fees, brokerage commissions or other expenses of investing. The ICE BofA U.S. Convertibles Index is a cap-weighted index of domestic U.S. corporate convertible securities, including mandatory convertible preferreds. The ICE BofA U.S. High Yield Index tracks the performance of USD-denominated, below investment grade rated corporate debt publicly issued in the U.S. domestic market. Subindexes for B-BB and CCC and lower track securities within the respective ratings ranges. The S&P 500 Index is an unmanaged index that measures the performance of securities of approximately 500 of the largest companies in the United States.

Past performance does not guarantee future results. This market insight has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing, or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain statements contained herein may represent future expectations or other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied in such statements. Actual results, performance, or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views, and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.

Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested.

Past performance does not predict future returns. If the currency in which the past performance is displayed differs from the currency of the country in which the investor resides, then the investor should be aware that due to the exchange rate fluctuations the performance shown may be higher or lower if converted into the investor’s local currency.

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