Monday, March 15, 2010

High Yield vs. Investment Grade Corporates

As of the end of February, the spread on the investment grade corporate bond index was ~170 bps and the high yield index ~650 bps (up from the 1994-2010 average of 140 bps and 510 bps respectively). Below is a chart of the variance between the two since 1994 (as far back as I was able to pull data).

Below is the relationship between this variance and the subsequent 12 month out/under performance of high yield relative to investment grade corporate bonds. As can be seen, there appears to be a weak relationship between spread variance and performance when spreads are "tight" (in this case less than 600 bps [in blue], where correlation is -0.31), but when spreads were north of 600 bps [in red], correlation spiked to 0.75 (though it is important to note that spreads have only been this wide in two periods and 19 months since 1994 [i.e. small sample set]).

Below is a chart of the above data in a different form broken out by spread "bucket" rather than as a scatter plot. Again, except when spreads were at "world is ending" levels (and the world didn't end), high yield has tended to underperform.

The important point I will make is that any investment in high yield is by definition... risky. Especially at relative "tight" levels coming out of the worst credit crisis since the Great Depression.

Source: Barclays Capital

1 comment:

  1. Very nice analysis!

    I would add one caveat to any historical analysis of spreads, namely that junk is junkier now than in the past, that is, the proportion of lowest-rated bonds is now much higher than the historical average. So the spreads are not completely comparable over time.

    This just strengthens the conclusion that junk is not a particularly promising bet right now.

    Here is a post of mine that covers the ratings distribution issue.

    Jim Fickett