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
Exhibit 1: 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
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
Exhibit 3: 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
Exhibit 4: 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.