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Should Corporate Bonds be Avoided?

June 28, 2011 - 0 comments

In recommended readings on Monday, June 27, Justin included an article from Larry Swedroe on 3 Reasons to Avoid Corporate Bonds.  Since we include corporate bonds in our portfolios, I thought it worthwhile to comment.

The three reasons Larry sites are:
• Corporate bonds mean equity-like risk exposure
• Returns haven’t been worth the risks
• You lose asset allocation control

While the three reasons given for avoiding corporate bonds are valid, it is important to note that there are ways to mitigate the risks involved.  Larry discusses these in a response to a question on the blog:

“First, clearly you have to distinguish the various forms of corporate debt, there is wide range from high investment grade to low investment grade, to junk bonds and then term risk can vary as well

Second, all corporate debt has some equity like risk in it. The higher the credit quality, the lower the figure and the shorter the maturity the lower the figure

Third, pretty much the only place that corporate credit risk has been well rewarded is in the ST, and with fallen angels (once investment grade that was cut to non investment grade status---as you get one time massive selling [sic] by those that cannot by charter hold non investment grade debt

Finally, if you take corporate credit risk (and I have no real problem with ST investment grade debt without call risks) then you should adjust your AA to account for the equity like risks, or otherwise taking more risk than you think [sic] you are. So for example, I have used DFA's ST funds and even the ST extended credit fund (but I count 10% of that fund as equity risk)”1

Our fixed income allocation in portfolios focuses on high quality, short term holdings, using broadly diversified pools, predominantly investing in Canadian bonds.  We recognize that there is some extra risk involved in corporate rather than government holdings, but by keeping credit quality high and maturity short, believe the risk is manageable.

1 http://moneywatch.bnet.com/investing/blog/wise-investing/3-reasons-to-avoid-corporate-bonds/2555/?tag=col1;blog-river

By: Kathleen Clough with 0 comments.
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