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
- Quantify the pickup (difference in yield-to-maturity, not just coupon).
- Compare durations and convexity to understand interest-rate sensitivity.
- Evaluate credit quality and default risk—check ratings and issuer fundamentals.
- Review call features and reinvestment scenarios.
- Account for transaction costs, taxes, and liquidity.
- 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.