First I know it makes a difference what % you use in the outcomes, but when I've run the data with different percentages in past high-grade lost, no matter what the percentage.
Try this piece I wrote which also cites the literature, two papers including Fridson'shttp://seekingalpha.com/article/58172-d ... gh-returns
Here is some other information
“Explaining the Rate Spread on Corporate Bonds,”3 by Edwin J. Elton, Martin J. Gruber, Deepak Agrawal, and Christopher Mann, posed three pertinent questions:
• How much of the spread between corporate and Treasury bonds is explained by expected losses from defaults? Some percentage of corporate bonds is likely to default, and defaults generally result in recovery rates below 100 percent. Furthermore, the lower the credit rating, the lower the recovery percentage. Investors must be compensated for the greater expected losses.
• How much of the spread is explained by the tax premium? Interest on U.S. government securities is not taxed at the state or local level. However, interest on corporate debt is taxed. Investors must be compensated for the tax differential.
• Is the incremental risk of corporate bonds systematic (nondiversifiable) or unsystematic (diversifiable)? Investors are compensated with risk premiums for systematic risks, but they are not compensated for unsystematic risks.
The study’s conclusions regarding these questions can be summarized this way:
• The difference in tax treatment and expected default losses does not adequately explain the spread. For example, the authors found that expected losses account for no more than 25 percent of the corporate spread. In the case of a 10-year A-rated corporate bond, just 18 percent of the spread was explained by default risk. The difference in tax treatment accounted for 36 percent of the spread. In other words, default risk accounts for a surprisingly small fraction of the premium in corporate rates over Treasuries. There must be another source of risk premium demanded by investors.
• The Fama/French Three-Factor Model (see Glossary) explains as much as 85 percent of the spread that is not accounted for by taxes and expected default loss. This means most of the spread is compensation for three risks: the risk of the overall stock market; the risk of small (versus large) companies; and the risk of value (versus growth) companies. The lower the credit rating—and the longer the maturity—the greater the explanatory power of the model (its inherent accuracy). Thus, much of the expected return to high-yield debt is explained by risk premiums associated with equities, not debt. These risks are systematic risks that cannot be diversified away.
A 2006 study, “Personal Taxes, Endogenous Default, and Corporate Yield Spreads,” by Howard Qi, Sheen Liu and Chunchi Wu, focused on the tax issue and found that personal taxes explain almost all of the spread between shorter-term high-grade bonds and Treasuries. That is exactly what we should expect, because there is almost no credit risk in short-term, high-quality bonds. Taxes explain about 60 percent of the spread for longer-term, high-quality bonds. This is logical, as the credit risk of corporate bonds—even high-grade ones—increases with time. But the picture is quite different for high-yield bonds: Personal taxes explain about 60 percent of the spread for shorter-term bonds and less than 40 percent for long-term bonds.4
These findings demonstrate three important facts. First, corporate debt contains very little risk that is not explained by other factors. As we have seen, most of the returns are explained by term risk, taxes and equity risks. Second, despite its low correlation to other portfolio assets, high-yield debt provides little benefit in terms of portfolio diversification. Third, it also helps explain why corporate bond spreads appear to be so large. (There is a tax component, as well as an equity component, in the security.)
And this paper
That high-yield bonds are hybrid securities is also supported by the findings of “Co-movements of Low-Grade Debt and Equity Returns of Highly Leveraged Firms,” a 1994 study by Hilary Shane that evaluated 208 low-rated bonds and an index of the stocks of the issuers represented in the bond portfolio. Shane concluded: “Significant positive correlations of the all-inclusive, low-grade bond portfolio with the matched equity portfolio and with the Treasury bonds support the intuition that low-grade bonds are hybrid securities.”
Here is another paper on the issue of hybrid security
One 2002 study on default risk, “Is Default Event Risk Priced in Corporate Bonds?”, by Joost Driessen, supports this theory. The author concluded that an event (default) risk premium is a significant determinant of excess corporate bond returns. Clearly, if there is an event that increases the likelihood of default, it will negatively impact the equity of the company, as well.7 That is why the Fama/French Three-Factor Model explains much of the spread not determined by default and taxes. High-yield returns move systematically with equities, and the risk of default increases when equity prices fall (and vice versa). The important point to remember is that correlations are not static values.
And other negative features of high yield
The problem for investors is that high-yield debt exhibits negative skewness. Mark Anson researched the period from January 1990 through June 2000 and found that high-yield bonds (as measured by the Salomon Smith Barney High Yield Composite Index) exhibited skewness of -0.43; similar to that exhibited by stocks. For the same period, the S&P 500 Index had skewness of -0.50.9
High-yield debt returns also exhibit high kurtosis.
Also from my book on alternatives
For the 29-year period from 1979 to 2007, the fund provided investors with a return of 9.01 percent per year. For the same period, the Lehman Brothers Intermediate Credit Bond Index, an index of investment grade bonds with maturities of one to ten years, returned 8.88 percent per year, almost matching the return of the Vanguard fund without taking the credit risks of junk bonds. Thus, while the spread between high-yield bonds and investment grade bonds can often be quite wide, the incremental return realized by investors was just 0.13 percent. This demonstrates investors should never confuse yield with returns. And that doesn't even take into account correlations. Nor the 2008 collapse.
As I showed in my book a more efficient alternative is simply to lower equity exposure and add small value tilt and stick with investment grade or Treasuries. You get superior results.
And here is what David Swensen, pretty smart CIO of Yale Endowment had to say
David Swensen, the highly regarded Chief Investment Officer of the Yale University endowment, stated: “Well-informed investors avoid the no-win consequences of high-yield fixed income investing.”
Here are some papers on subject
Martin S. Fridson, “Do High-Yield Bonds Have an Equity Component?” Financial Management (Summer 1994), p. 83.
Bradford Cornell and Kevin Green, “The Investment Performance of Low-grade Bond Funds,” Journal of Finance (March 1991), p. 32 and 47.
Dale Domain and William Reichenstein, Returns-Based Style Analysis of High-Yield Bonds, Journal of Fixed Income, Spring 2008.
Mark J.P. Anson, The Handbook of Alternative Assets, (Wiley, 2002), pp. 99-100.
Antti Ilmanen, Rory Byrne, Heinz Gunasekera and Robert Minikin, “Which Risks Have Been Best Rewarded?” Journal of Portfolio Management (Winter 2004), p. 54.
Martin Fridson, “Original Issue High-Yield Bonds,” Journal of Portfolio Management (Fall 2007).
Hope that helps