Yield Pickup

Yield Pickup

What it is

A yield pickup is the additional yield an investor gains by selling a lower-yielding bond and buying a higher-yielding one. The objective is to improve income and potentially risk-adjusted returns within a fixed-income portfolio.

How the strategy works

The strategy involves swapping bonds that pay less interest for bonds that pay more. The pickup equals the difference in yields (for example, selling a bond yielding 4% to buy one yielding 6% produces a 2% pickup).

Yields differ for several reasons:
* Maturity: Longer-maturity bonds generally pay higher yields to compensate for greater interest-rate sensitivity (duration).
* Credit quality: Lower-rated issuers must offer higher yields to attract buyers.
* Coupon and yield-to-maturity differences.
* Market mispricing relative to comparable issues.

A straightforward form is the pure yield-pickup swap: sell bonds in the portfolio that appear overpriced (low yield) and buy similar bonds that are underpriced (higher yield).

Example

You hold a corporate bond yielding 4% and switch to a different corporate bond yielding 6%. The immediate yield pickup is 2% (6% − 4%). The gain may come from a higher coupon, a higher yield-to-maturity, or both.

Main risks

• Interest-rate risk: Higher-yielding bonds often have longer maturities and are more sensitive to rate changes; rising market rates can cause capital losses.
• Credit/default risk: Higher yields often compensate for lower credit quality. The extra yield may reflect increased default probability.
• Call and reinvestment risk: High-coupon bonds may be callable; issuers may redeem them when rates fall, forcing reinvestment at lower yields.
• Liquidity and transaction costs: Trading to pick up yield can incur bid-ask spreads and commissions that reduce or negate the pickup.
• Timing and market risk: If rates move adversely during the trade or holding period, losses can result despite a higher starting yield.

When to consider a yield pickup

• You need higher income and accept incremental credit or duration risk.
• Comparable bonds show temporary mispricing (one appears underpriced relative to peers).
• The pickup compensates adequately for added duration or credit risk after accounting for costs and taxes.

Practical steps before executing

1. Quantify the pickup (difference in yield-to-maturity, not just coupon).
2. Compare durations and convexity to understand interest-rate sensitivity.
3. Evaluate credit quality and default risk—check ratings and issuer fundamentals.
4. Review call features and reinvestment scenarios.
5. Account for transaction costs, taxes, and liquidity.
6. Consider how the trade fits portfolio objectives and risk tolerance.

Key takeaways

• Yield pickup increases income by switching to higher-yield bonds but typically involves additional interest-rate or credit risk.
• Successful pickup strategies weigh the extra yield against longer duration, lower credit quality, call features, and trading costs.
• Analyze yield-to-maturity, duration, credit, and call risk before making a swap to ensure the pickup justifies the added exposures.