A pickup, or yield pickup, is the additional interest an investor gains by selling one bond and buying another that has a higher return. It’s a trading strategy used by both professional and non-professional investors.
The extra interest a buyer gains by dropping the lower-yielding instrument and buying the higher-yielding one is the “pickup.”
When interest rates rise, investors can see a better yield by shedding old bonds and buying new ones.
But when interest rates hold steady or drop, investors can only record a better yield if they buy already existent, higher interest-rate bonds at a markup, or to buy risker bonds that are higher yielding.
Bonds are mostly traded in the first place so that investors can get a pickup, with market participants always seeking higher yields.
As interest rates overall rise and fall, the yield paid on bonds increases or decreases. Bond prices and yields move in opposite directions. If interest rates move higher, investors can achieve a better yield, or pickup, by selling their old bonds and buying new ones. Assuming that the new and old bonds have the same level of risk, the investor has just improved that investment’s return without taking on any more risk.
However, if interest rates are steady or declining, the only way to achieve a pickup is to buy existing, higher interest-rate bonds at a premium or to buy higher-risk bonds that carry a higher yield. In these cases, a pickup strategy may entail cost or risk. The opportunity to get a pickup is the most common reason why bonds are traded.
A related term is the pure yield pickup swap. In this transaction, a lower-yield bond is traded for a higher-yield bond. The trader accepts a greater risk in order to achieve a greater return.
In addition to a pickup, there are also other reasons why bonds are traded. One is an anticipated credit upgrade for a bond issuer, particularly if the upgrade will move the bond from junk status to investment grade. A bond trader may also make a credit-defense trade to limit a portfolio’s exposure to default risk, or a sector-rotation trade to benefit from anticipated out-performance in a particular industry or sector.
Investors also use yield curve adjustment trades to change the duration of the bonds in a portfolio based on expectations about the direction interest rates will go. When they anticipate rising interest rates, they want to shorten the duration of their portfolios. When they anticipate declining interest rates, they want to lengthen the duration of their portfolios. In any case, the traders are aiming for a yield pickup.