Another look at corporate bonds

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Another look at corporate bonds

Post by larryswedroe »

http://www.etf.com/sections/index-inves ... rate-bonds

Hard to see the argument for them

Larry
User avatar
cfs
Posts: 4154
Joined: Fri Feb 23, 2007 12:22 am
Location: ~ Mi Propio Camino ~

Re: Another look at corporate bonds

Post by cfs »

Thanks.

Thanks Larry for another good article and thanks for the heads-up on the corporate bonds. Looking forward to your next book on bonds.

Thanks for reading.
~ Member of the Active Retired Force since 2014 ~
mptfan
Posts: 7201
Joined: Mon Mar 05, 2007 8:58 am

Re: Another look at corporate bonds

Post by mptfan »

larryswedroe wrote: Hard to see the argument for them

Larry
It's quite easy to see the argument for them...corporate bonds pay higher dividends than treasury bonds. You may not agree with the argument, but I assume you can at least see it?
User avatar
SpringMan
Posts: 5422
Joined: Wed Mar 21, 2007 11:32 am
Location: Michigan

Re: Another look at corporate bonds

Post by SpringMan »

I have read that Jack Bogle likes them, VICBX, VG intermediate term corp index institutional and I believe Bill Bernstein has recommended VG short term investment grade. When experts disagree it may not matter much.
Best Wishes, SpringMan
User avatar
siamond
Posts: 6003
Joined: Mon May 28, 2012 5:50 am

Re: Another look at corporate bonds

Post by siamond »

This was a good thought-provoking article, thanks for sharing.

I am not sure to agree with everything, e.g. the slightly higher volatility doesn't seem meaningful, comparing with CDs comes with clear issues (harder to withdraw/rebalance with CDs), plus I have to wonder if historical analysis for bonds should carry the same weight as for equities. I also would care much more about IT corporates than LT corporates. But still, very interesting content.

Quick question: was this analysis done based on SBBI historical data, or another source?
Trader/Investor
Posts: 264
Joined: Wed Dec 02, 2015 8:35 pm

Re: Another look at corporate bonds

Post by Trader/Investor »

mptfan wrote:
larryswedroe wrote: Hard to see the argument for them

Larry
It's quite easy to see the argument for them...corporate bonds pay higher dividends than treasury bonds. You may not agree with the argument, but I assume you can at least see it?
In my short time here I have learned Mr Swedroe is very biased against corporate bonds - especially junk corporates. His forte is research. Some of us here have had very positive experiences with corporate bonds in the real world of investing and in my case trading. You can't argue politics, you can't argue religion and in the investment world you can't argue corporate bonds with Larry Swedroe. So I will respectfully disagree with Mr Swedroe and leave it at that.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: Another look at corporate bonds

Post by larryswedroe »

MPTFAN
Higher yield isn't sufficient justification, you need to also look at how risks mix, and of course costs. Like I said, I find it hard to make an argument for including them when CDs are available, there just isn't any evidence to support it

Trader/Investor
I have no biases going in, no reason not to recommend buying them. I just follow the research/evidence. The historical evidence makes the case, not me
Larry
Last edited by larryswedroe on Fri Jul 15, 2016 10:51 am, edited 1 time in total.
lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 10:55 pm

Re: Another look at corporate bonds

Post by lack_ey »

Trader/Investor wrote:
mptfan wrote:
larryswedroe wrote: Hard to see the argument for them

Larry
It's quite easy to see the argument for them...corporate bonds pay higher dividends than treasury bonds. You may not agree with the argument, but I assume you can at least see it?
In my short time here I have learned Mr Swedroe is very biased against corporate bonds - especially junk corporates. His forte is research. Some of us here have had very positive experiences with corporate bonds in the real world of investing and in my case trading. You can't argue politics, you can't argue religion and in the investment world you can't argue corporate bonds with Larry Swedroe. So I will respectfully disagree with Mr Swedroe and leave it at that.
Are you suggesting that it's better to draw from personal experience when making decisions over more comprehensive and less biased historical evidence?


For what it's worth, some of the main ways to make a historical case for corporate bonds would be to point out here that
1. You don't have to go to the far end of the yield curve, and the main comparisons here were at the long end. What about other parts of the yield curve?
2. A 20-year corporate bond has a lower duration than a 20-year Treasury, so you're not apples-to-apples comparing securities with equivalent term risk (you're not isolating the effect of a purely credit risk difference, which is somewhat misleading).
3. It's a somewhat different asset class, but credit risk wasn't all that unrewarded in EM bonds, was it?

Tax issue, fund cost issue, liquidity issue, lower diversification with equities, etc. are all still relevant and true, of course. Also, as noted, an individual investor should be looking at spreads over max(Treasuries, CDs).
Last edited by lack_ey on Fri Jul 15, 2016 10:28 am, edited 1 time in total.
mptfan
Posts: 7201
Joined: Mon Mar 05, 2007 8:58 am

Re: Another look at corporate bonds

Post by mptfan »

larryswedroe wrote:MPTFAN
Higher yield isn't sufficient justification, you need to also look at how risks mix, and of course costs. Like I said, I find it hard to make an argument for including them when CDs are available, there just isn't any evidence to support it
Larry, you are entitled to your opinion, but when you go so far as to say you cannot "see" any argument or any evidence for holding corporate bonds, then you go too far. It is one thing to say you have looked at the evidence and come to an opinion, it is quite another to say I do not "see" any evidence to support any contrary opinion.

Clearly there are many people who disagree with you about the merits of holding corporate bonds, and corporate bonds are a significant portion of the bond market, and Vanguard has a variety of funds that include or focus on corporate bonds...so either 1) all of those people who own corporate bonds are just fools and they "see" something that does not exist, or 2) your view is so biased that you fail to "see" something that does exist.
Trader/Investor
Posts: 264
Joined: Wed Dec 02, 2015 8:35 pm

Re: Another look at corporate bonds

Post by Trader/Investor »

lack_ey wrote:
Trader/Investor wrote:
mptfan wrote:
larryswedroe wrote: Hard to see the argument for them

Larry
It's quite easy to see the argument for them...corporate bonds pay higher dividends than treasury bonds. You may not agree with the argument, but I assume you can at least see it?
In my short time here I have learned Mr Swedroe is very biased against corporate bonds - especially junk corporates. His forte is research. Some of us here have had very positive experiences with corporate bonds in the real world of investing and in my case trading. You can't argue politics, you can't argue religion and in the investment world you can't argue corporate bonds with Larry Swedroe. So I will respectfully disagree with Mr Swedroe and leave it at that.
Are you suggesting that it's better to draw from personal experience when making decisions over more comprehensive and less biased historical evidence?


For what it's worth, some of the main ways to make a historical case for corporate bonds would be to point out here that
1. You don't have to go to the far end of the yield curve, and the main comparisons here were at the long end. What about other parts of the yield curve?
2. A 20-year corporate bond has a lower duration than a 20-year Treasury, so you're not apples-to-apples comparing securities with equivalent term risk (you're not isolating the effect of a purely credit risk difference, which is somewhat misleading).
3. It's a somewhat different asset class, but credit risk wasn't all that unrewarded in EM bonds, was it?

Tax issue, fund cost issue, liquidity issue, lower diversification with equities, etc. are all still relevant and true, of course. Also, as noted, an individual investor should be looking at spreads over max(Treasuries, CDs).
Are you suggesting that it's better to draw from personal experience when making decisions over more comprehensive and less biased historical evidence?


You are darn right! Like 50 years of personal experiences in the markets. 19 of those years just spinning my wheels until I came to the realization there are no experts in this business and if i was ever going to become successful I better become my own expert and find what works for me. I have never been impressed with academic research.
magneto
Posts: 1060
Joined: Sun Dec 19, 2010 9:57 am
Location: On Chesil Beach

Re: Another look at corporate bonds

Post by magneto »

If we subscribe to the "take your risk on the Stock-side not the Fixed-Income Side", then we will be looking
to invest Fixed Income in :-

1. Cash (CDs etc)
2. Short-Term Treasuries
3. Short-Term IG Bonds.

The snag with Short-Term Treasuries is the probable -ve real yield, dependent on the investor's view of inflation going forward.

However Larry among relevant points, draws our attention to the performance behaviour re overall portfolio construction, rather than it's individual components, all as per MPT.

This is far from a clear issue !!!
'There is a tide in the affairs of men ...', Brutus (Market Timer)
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: Another look at corporate bonds

Post by larryswedroe »

Trader/investor
Like I said, I, me personally, cannot see any reason to recommend them. There's nothing in the historical evidence that makes the case. Especially when CDs are options. Cannot see how you can say it's going to far. It's my opinion based on the evidence. If you have evidence to show otherwise, and inside of portfolios and after all costs and compared to CDs then I'd love to see it. I haven't found any yet. Certainly not enough to make the compelling case.

Look the premium EVEN BEFORE expenses is tiny, after expenses it's negative, and that's against Treasuries, not much higher yielding CDs. And then you have the issue of correlations shifting the wrong way at the wrong time.

Now, what little evidence there is shows that FALLEN ANGELS, once investment grade but downgraded have provided more appropriate risk adjusted returns because of huge selling pressure on the downgrade and then you also pick up a liquidity premium (which should be accounted for). That's the academic findings. Also on the shorter end of the curve where call risk is gone and credit risk for investment grade bonds is low you can make a small case for them relative to Treasuries, but not versus CDs.

If you think there's something wrong in the evidence presented, show us what's incorrrect. Not opinions, but facts.
Larry
Trader/Investor
Posts: 264
Joined: Wed Dec 02, 2015 8:35 pm

Re: Another look at corporate bonds

Post by Trader/Investor »

larryswedroe wrote:Trader/investor
Like I said, I, me personally, cannot see any reason to recommend them. There's nothing in the historical evidence that makes the case. Especially when CDs are options. Cannot see how you can say it's going to far. It's my opinion based on the evidence. If you have evidence to show otherwise, and inside of portfolios and after all costs and compared to CDs then I'd love to see it. I haven't found any yet. Certainly not enough to make the compelling case.

Look the premium EVEN BEFORE expenses is tiny, after expenses it's negative, and that's against Treasuries, not much higher yielding CDs. And then you have the issue of correlations shifting the wrong way at the wrong time.

Now, what little evidence there is shows that FALLEN ANGELS, once investment grade but downgraded have provided more appropriate risk adjusted returns because of huge selling pressure on the downgrade and then you also pick up a liquidity premium (which should be accounted for). That's the academic findings. Also on the shorter end of the curve where call risk is gone and credit risk for investment grade bonds is low you can make a small case for them relative to Treasuries, but not versus CDs.

If you think there's something wrong in the evidence presented, show us what's incorrrect. Not opinions, but facts.
Larry
Facts? I am a trader not an investor/researcher/academician. My facts would be my 1040s for the past 20+ years. I would gladly send them to you. If you recall, back in the days I always provided real money brokerage statements to validate myself and my trading claims. Something the crooks, con men, and charlatans in the trading world could never do. But we are getting off base here. We live in two different worlds so I have no doubt your research is spot-on. You and I always got along in the distant past and I always respected you. But you seem to have become a bit more opinionated and vocal now than when I knew you in the 90s. Maybe that is because opinionated and vocal sells books??? It worked for me but then my last book was way back in 1999.
lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 10:55 pm

Re: Another look at corporate bonds

Post by lack_ey »

Are we even having the same discussion, though?

The question here is about the characteristics of (broad exposure to) the asset class, not a performance record or the possibility for such a record by trading within the asset class.

Or are you really contending that personal experience gives better insight into the former than looking through the data? If somebody asks you about the historical returns of US stocks over time, you do get a better view from asking a stock trader about their own record or checking the S&P 500?
Trader/Investor
Posts: 264
Joined: Wed Dec 02, 2015 8:35 pm

Re: Another look at corporate bonds

Post by Trader/Investor »

lack_ey wrote:Are we even having the same discussion, though?

The question here is about the characteristics of (broad exposure to) the asset class, not a performance record or the possibility for such a record by trading within the asset class.

Or are you really contending that personal experience gives better insight into the former than looking through the data?
My bad, you are correct, we are not having the same discussion here. I am a huge fan of this forum, recommend it to all my friends, and believe 99.5% of investors would be best served by being a Boglehead. I just happen to be in that outlier percentage.
User avatar
saltycaper
Posts: 2650
Joined: Thu Apr 24, 2014 8:47 pm
Location: The Tower

Re: Another look at corporate bonds

Post by saltycaper »

Larry Swedroe wrote:
The following table covers the 90-year period from 1926 through 2015, and compares the results of two 60/40 portfolios rebalanced annually.

. . .

FDIC-insured CDs, which also have no credit risk (as long as you remain within the limits of the insurance), typically carry significantly higher yields that likely would more than wipe out the advantage in yield corporate bonds have over Treasurys.
How do we know higher CD yields would overcome the difference? I'm not saying they wouldn't, but I don't see sufficient data presented to justify the claim. As you always say, it's not yield in a vacuum, but how the portfolio works as a whole. I find it hard to believe that corporate bonds have never provided more money to rebalance into stocks than if you had held a CD over the same time period, a falling rate environment for instance where the gains from falling rates outpace losses due to credit/default risk.
Larry Swedroe wrote:
It must also be observed that the liquidity and the credit risks inherent in corporate bonds showed up at a time when stock prices were collapsing, demonstrating that credit/default risk and equity risk are related.
Just related? Have you softened your position on bonds actually containing equity risk, or am I wrong and you never said that? Equity-like?
Quod vitae sectabor iter?
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: Another look at corporate bonds

Post by nedsaid »

Trader/Investor wrote:
larryswedroe wrote:Trader/investor
Like I said, I, me personally, cannot see any reason to recommend them. There's nothing in the historical evidence that makes the case. Especially when CDs are options. Cannot see how you can say it's going to far. It's my opinion based on the evidence. If you have evidence to show otherwise, and inside of portfolios and after all costs and compared to CDs then I'd love to see it. I haven't found any yet. Certainly not enough to make the compelling case.

Look the premium EVEN BEFORE expenses is tiny, after expenses it's negative, and that's against Treasuries, not much higher yielding CDs. And then you have the issue of correlations shifting the wrong way at the wrong time.

Now, what little evidence there is shows that FALLEN ANGELS, once investment grade but downgraded have provided more appropriate risk adjusted returns because of huge selling pressure on the downgrade and then you also pick up a liquidity premium (which should be accounted for). That's the academic findings. Also on the shorter end of the curve where call risk is gone and credit risk for investment grade bonds is low you can make a small case for them relative to Treasuries, but not versus CDs.

If you think there's something wrong in the evidence presented, show us what's incorrrect. Not opinions, but facts.
Larry
Facts? I am a trader not an investor/researcher/academician. My facts would be my 1040s for the past 20+ years. I would gladly send them to you. If you recall, back in the days I always provided real money brokerage statements to validate myself and my trading claims. Something the crooks, con men, and charlatans in the trading world could never do. But we are getting off base here. We live in two different worlds so I have no doubt your research is spot-on. You and I always got along in the distant past and I always respected you. But you seem to have become a bit more opinionated and vocal now than when I knew you in the 90s. Maybe that is because opinionated and vocal sells books??? It worked for me but then my last book was way back in 1999.
I guess I am the patron saint of lost causes so I will take up a defense of Trader/investor and a lesser defense of Larry Swedroe. First, let me defend Swedroe a bit.

First of all, this points to the importance of good investment records. I have kept mine on Quicken for just over 20 years and I have spreadsheets going back before then. My memory is pretty good but looking through my records found that my recollection was a bit hazy. For example, I remembered that I sold 30% of my stocks in early 2000. What I did was sell 30% of my stock mutual funds and since half of my stock investments were in individual stocks (which I left alone), my sales of stock where 15% and not 30%. So that shows the limits of investor "experience." Sometimes we are legends in our own minds, we tend to remember the successes and forget or downplay the failures. I have tried my best to be objective about my own experiences.

Second, memories are tied to emotions. Our memories might be in the larger sense, largely correct, but when we look at the actual data, what actually happened might have been a bit different particularly in those pesky details. So my memories that are heavily influenced by the emotions I felt at the time may have exaggerated a bit, good or bad, what really happened. So that shows the limitations of investor experience. It would be the Beardstown Ladies' effect.

Now on to defending Trader/investor. I will say that nothing locks in investing lessons than investing real money and buying real investments with them. There are real life emotions experienced as you watch how those investments perform under different market conditions. Those concepts that seem distant and academic and theoretical get really locked into the brain with real life experiences. For example, two 50% down bear markets during the 2000's locked into my brain the virtues of investment grade bonds in a way that no amount of discussion of academic research could have. There is also a lot of wisdom in the late Yogi Berra's comment that "You can observe a lot by watching."

One thing, I guess, that puts a burr under my saddle, is when Larry just dismisses the real life experiences of real investors with real money and real investments. If a person amasses a fortune by investing in individual blue chip stocks and reinvesting the dividends, I say bully for him or bully for her. That person had real life success, a real life portfolio, and real life investment results. Now perhaps the academics might say the result would have been better with index funds but that still doesn't detract from the accomplishment.

So I can understand the frustration that Trader/investor feels towards Larry. When I mention that I have invested in individual stocks throughout most of my investment career, I draw gasps from the audience. You can't do that! You don't know the risks you are taking! Then I get what I call the "reefer madness" warnings about individual stocks. My gosh, I may as well have told everyone that I was taking illegal drugs! But saying that, I learned about indexing and the academic research, and I have over time made changes to my portfolio. I don't ignore the evidence.

It is like the folks here who dismiss the accomplishments of people like Warren Buffett and Peter Lynch. My answer to that is start a conglomerate and report back in 15 years. Or run other people's money for 15 years and report back on the results. Oh, they were lucky! The simple math says that it can't be done! Swedroe even wrote a book about how Buffett did it but the last I checked, Mr. Swedroe did not have his own mini-Berkshire/Hathaway or anything close. Swedroe's accomplishments are considerable but he couldn't replicate what Buffett did.

What I am trying to say is though investor experience isn't everything and has its limitations, it is nevertheless very valuable. Like Yogi Berra, I observe a lot by watching and report here what I have learned. I have been told numerous times that I was wrong and didn't know what I was talking about but when went back and checked found that most often I was right after all. It is like I didn't see what I saw or experience what I experienced. Somehow, it was all phony or not real, like a movie shot in the backlots of Hollywood.
A fool and his money are good for business.
soboggled
Posts: 901
Joined: Mon Jun 27, 2016 10:26 am

Re: Another look at corporate bonds

Post by soboggled »

Not sure the difference in return over the last 5 years (i.e., VICSX/VFIDX vs. VBTLX) is insignificant, especially if held in a tax-deferred low-equity portfolio.
However, the current yield differentials are now very small and probably don't warrant even the small risk. CDs are also relatively looking good.
An argument for bond timing?
lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 10:55 pm

Re: Another look at corporate bonds

Post by lack_ey »

soboggled wrote:Not sure the difference in return over the last 5 years (i.e., VICSX/VFIDX vs. VBTLX) is insignificant, especially if held in a tax-deferred low-equity portfolio.
However, the current yield differentials are now very small and probably don't warrant even the small risk.
An argument for bond timing?
In a vacuum I think there's an argument for taking credit risk or that it's better when spreads are higher, sure. I can't recall the specifics of the data and how profitable this would have been over time, though.

Also, note that higher spreads arise at least in large part from higher estimation of risk (for example, you see higher spreads during a financial crisis, liquidity concerns, etc.), so this is kind of along the lines of extra return from extra risk rather than any kind of free lunch. In addition, if corporate bonds are cheaper when stocks are cheaper, that doesn't really help you all that much. I don't think it's as clear as some might think overall, with market timing of anything being less fruitful and more fraught than it might seem.

By the way, I don't think your assessment of current yield spreads is accurate, at least relatively speaking. Now is not all that low.
Image

If it gets really low, you do have to wonder what return you are getting for the risk, considering that outcomes are kind of asymmetrical: limited upside with more significant potential downside.
User avatar
siamond
Posts: 6003
Joined: Mon May 28, 2012 5:50 am

Re: Another look at corporate bonds

Post by siamond »

siamond wrote:This was a good thought-provoking article, thanks for sharing. [...]
Quick question: was this analysis done based on SBBI historical data, or another source?
Seems that my question was lost in the interesting discussion triggered by Trader/Investor! Larry, would you mind telling?

Also, while I'm at it, another question: is there a solid historical track record for corporate bonds in another country? I checked the usual Barclays Equity Gilt study for the UK, and corporate bonds are only tracked starting in 1999, which is way too short of a time period to draw any conclusion.
User avatar
Kevin M
Posts: 15750
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: Another look at corporate bonds

Post by Kevin M »

For those of us who have been learning from Larry for years, this article is simply a reinforcement of what we've already learned from him. Always good to repeat important messages, so thanks for the article, Larry.

Larry and I are on the same page when it comes to CDs. I have about 70% of my fixed income in CDs purchased directly from banks and credit unions (direct CDs). My CD yield premium (over Treasuries of same maturities) purchased over the last 5.5 years is about 115 basis points (and about 130 basis points for CDs I still own). And as Larry mentions in the article, the early withdrawal option significantly reduces term risk, giving CDs and even larger advantage over Treasuries.

Where I depart from Larry's advice is that I have held about 15%-20% of my fixed income in investment-grade bond funds during the last 5.5 years (with another 10%-15% in muni bond funds in taxable accounts), with that percentage decreasing as interest rates fell from late 2010 levels to the lows in 2012. I have done this because I've wanted to maintain some exposure to term risk, which direct CDs do not provide, to hedge against further declines in bond yields, and because the addition of credit risk provided yields that were higher than the CDs I was buying (which Treasuries did not, obviously).

Larry will argue that I could have accomplished the same thing more efficiently with a higher allocation to stocks, and I'm sure he's right about that. The thing is that I sleep better with my relatively low allocation to stocks (based on low need to take risk, which I learned about from Larry), and taking on some equity-like risk in corporate bonds doesn't bother me as much as increasing my equity allocation, irrational though that may be. Willingness to take risk (also learned about from Larry) encompasses the emotional factors of investing, so perhaps Larry will acknowledge some merit to my perhaps somewhat-irrational holding of corporate bonds based on the risk paradigm I learned about from him ;-)

I think a more pure implementation of taking some term risk to benefit from the potential flight-to-safety benefit we have seen from Treasuries in recent years would be to limit my bond holdings to long-term Treasuries, which have provided much higher returns than intermediate-term Treasuries during flight-to-safety scenarios. As I've mentioned in other posts, I've just never been able to bring myself to buy Treasuries, since the yield premiums on CDs have been so rich over the last 5+ years.

Now we're seeing the 20-year Treasury yield at 1.84%, which I can easily beat with a 5-year direct CD with much, much less term risk. Yield on Vanguard Intermediate-Term Treasury fund is only 1.04%, and for the long-term Treasury fund it's 2.01%, which I can also beat with a 5-year CD, and I'm getting 3% on a 7-year CD I'm buying now. By contrast, SEC yield on Vanguard Intermediate-Term Investment-Grade fund is 2.39%, somewhat higher than the 2.05% on a Synchrony Bank 5-year CD, and SEC yield on the long-term investment-grade fund is 3.45%, beating even the 7-year CD at 3%. So call me a yield chaser (with a small portion of my fixed income), but if I'm going to own bonds, I want to earn a higher yield than I can get on CDs.

How has this worked out? If we look at 5-year returns for intermediate-term Vanguard bond funds, it appears that both term risk and credit risk have been rewarded. Five-year return for int-term Treasury is 3.5%, and for int-term investment-grade, a fund I use, it's 5.11%. The more pure VG int-term corporate fund has a five-year return of 5.82%. For the long-term funds, Treasuries have done better, with a 5-year return of 10.28% vs. 9.42% for the long-term investment-grade fund, but for the very small position I've had in the latter, I'm a happy camper.

Of course as Larry teaches us, we don't want to confuse strategy with outcome, so we shouldn't get too cocky about the great returns to bonds in recent years, whether we're looking at rewards for term risk or credit risk. The next five years could be very different. Or, rates could fall even further, providing yet more reward for taking term risk (and maybe even credit risk). So the closer bond yields get to 0%, the more I'll shift into CDs, since the term risk will have less upside potential (even if rates fall a bit below 0%). When rates have risen from their lows in recent years, I've shifted a bit back into bond funds. Lately, with yields hitting historic lows and prices at historic highs, I've been shifting a bit more out of bond funds, especially longer-term funds.

Thanks to Larry for all the great lessons he's taught us over the years. I don't follow his advice in all respects, but I always pay careful attention to what he teaches us. Some of the most important investment lessons I've learned have been from him.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
tbradnc
Posts: 1532
Joined: Wed Apr 02, 2008 8:30 am

Re: Another look at corporate bonds

Post by tbradnc »

SpringMan wrote: When experts disagree it may not matter much.
This is why my only bond fund is Vanguard Intermediate-Term Bond Index Fund Admiral Shares (VBILX).

Everybody gets a trophy.
User avatar
dwickenh
Posts: 2304
Joined: Sun Jan 04, 2015 8:45 pm
Location: Hills of Eastern Tennessee

Re: Another look at corporate bonds

Post by dwickenh »

Thanks to Larry for all the great lessons he's taught us over the years. I don't follow his advice in all respects, but I always pay careful attention to what he teaches us. Some of the most important investment lessons I've learned have been from him.

Kevin

+1 on your post Kevin,

Dan
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: Another look at corporate bonds

Post by larryswedroe »

Salty
CD spreads are typically 30-60bp more than Treasuries, and often more than that. And many also come with very low early redemption which corporates don't. And given the pre expense premium has been under 30bp and trading costs have to be included, let alone the ER of the fund you need, think it's safe assumption.

As to personal experiences, they are anecdotes, not evidence since they cannot be replicated by others (unless were passive in index or similar funds).
And we don't even know if the anecdote is accurate, nor whether all costs and risk-adjustments have been made.

all my data comes from a returns program provided by DFA

As to equity risk. Yes they have equity risks, that's just terminology, the risks relate to equities and that is simple basic finance 101, and the research confirms the theory.

As Martin Fridson explained in his 1994 paper “Do High-yield Bonds Have an Equity Component?”: “In effect, a corporate bond is a combination of a pure interest rate instrument and a short position in a put on the issuer’s equity. The put is triggered by a decline in the value of the issuer’s assets to less than the value of its liabilities, resulting in a default — putting the equity to the bondholders. For a highly-rated company, the put is well out of the money and is not likely to be exercised. The option consequently has a negligible impact on the price movement of the bonds, which is more sensitive to interest rate fluctuations. In the case of a high-yield bond, however, default is a realistic enough prospect to enable the equity put to affect the bond’s price materially. With the equity-related option exerting a greater influence on its price movement, the high-yield bond will track government bonds (pure interest rate instruments) less closely than the investment-grade bond does.”
DaufuskieNate
Posts: 605
Joined: Wed May 28, 2014 11:53 am

Re: Another look at corporate bonds

Post by DaufuskieNate »

A quote from the article: "As I have discussed many times, investors should not consider assets in isolation. Instead, they should consider how an asset’s addition impacts their portfolio’s risk and return."

This point often gets lost in a discussion like this. Bonds are mostly used in a portfolio and are mixed with equities. Safer bonds, like Treasuries or CD's, mix well with equities. They arguably do a better job of reducing the standard deviation of portfolio returns, cutting tail risks and lowering the correlation of the portfolio to U.S. equity returns.

It's not Pepsi vs. Coke. It's Rum & Coke vs. Rum & Pepsi. Totally different perspective.
User avatar
siamond
Posts: 6003
Joined: Mon May 28, 2012 5:50 am

Re: Another look at corporate bonds

Post by siamond »

Since I have the SBBI/Ibbotson historical returns handy, I assembled a customized version of the Simba spreadsheet with several 60/40 portfolios:
- Large-Caps + Long-Term Government Bonds (reference for telltale charts)
- Large-Caps + Long-Term Corporate Bonds
- Large-Caps + mix 50/50 LT Gov/Corp
- Large-Caps + Intermediate-Term Government Bonds (not used in telltale charts)

Here is the 1972-2015 outcome - click on the image for a larger display. We can clearly see some of the key points Larry made, the very similar returns, the slightly higher std-deviation for corporates, and the disturbing tendency of corporates to drop in time of stock crisis (notably in 2008).

Image

Here is the 1926-2015 outcome - click on the image for a larger display. If you squint a bit, you'll see the same points being illustrated. Also note that the slightly better returns from corporates mostly come from the very first decade (could very well be due to inaccurate historical records).

Image

What happened during all these years is clearly highly dependent on the interest rates though (going up or down for decades), so I remain a bit wary to generalize too fast, and personally I'll stick to Jack's recommendation to use something like VBILX (50/50 Gov/Corp) nowadays. Unfortunately, SBBI doesn't track IT Corporates, as I would have been curious to extend the analysis.
ANC
Posts: 141
Joined: Sat Mar 01, 2014 6:59 pm

Re: Another look at corporate bonds

Post by ANC »

larryswedroe wrote:Salty
As Martin Fridson explained in his 1994 paper “Do High-yield Bonds Have an Equity Component?”: “In effect, a corporate bond is a combination of a pure interest rate instrument and a short position in a put on the issuer’s equity. The put is triggered by a decline in the value of the issuer’s assets to less than the value of its liabilities, resulting in a default — putting the equity to the bondholders. For a highly-rated company, the put is well out of the money and is not likely to be exercised. The option consequently has a negligible impact on the price movement of the bonds, which is more sensitive to interest rate fluctuations. In the case of a high-yield bond, however, default is a realistic enough prospect to enable the equity put to affect the bond’s price materially. With the equity-related option exerting a greater influence on its price movement, the high-yield bond will track government bonds (pure interest rate instruments) less closely than the investment-grade bond does.”
I am shocked, shocked to find equity risk inside a bond issue.

But what if we take this short equity put for what it is? There are times when high yield investors sell these things as if they had no put at all, as if they are in the back of the line at liquidation like common stock holders. I would not try this at home, but a good bottom-up equities manager can recognize these opportunities and take advantage of these mispricings, such as this winter or in 2009. If there is a debt-to-equity swap in restructuring, they may even end back up with a stock holding with greater upside.

It is easy to get scared of derivatives just by their mention. But they are not necessarily bad. Insurance companies can make good money selling short puts as car and property insurance. If the counterparty (policyholder) is willing to pay the price upfront, there is money to be made.
User avatar
nisiprius
Advisory Board
Posts: 52105
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Another look at corporate bonds

Post by nisiprius »

I don't think one needs to do much quantitative analysis, the broad lines are pretty clear to anyone who was paying attention in 2008-2009. I really am baffled by all the love corporate bonds have been getting lately, although I think part of the answer lies in the five-year returns at October-2008-plus-five-years. I swear that people were impressed by the five-year returns and ignoring the fact that a lot of those returns just amounted to climbing out of a hole that Total Bond and treasuries never fell into.

Anyway, it really seems pretty clear to me that
1) Corporate bonds have meaningfully more risk than government issues, but it still not comparable to the risk of stocks
2) Corporate bonds have meaningfully more return than government issues, but it's "meaningful," not "huge"
3) Corporate bonds are said to have "equity risk" because, as illustrated by 2008-2009, it shows up at the same time as equity risk
4) Corporate bonds are still, darn it all, bonds, not stocks, and a 10% drop isn't the same as a 50% drop
5) Investment-grade corporate bonds are investment-grade bonds, and they are nowhere near as risky as junk ("high-yield") bonds.

Blue: Vanguard Intermediate-Term Investment-Grade, not a pure corporate bond fund but mostly corporates.
Orange: Vanguard Total Bond Market Index Fund
Green: Vanguard High-Yield Corporate Bond Fund
Yellow: Vanguard Total Stock Market Index Fund

Look at the declines in 2008-2009 and look at where they are today. Could there possibly be a prettier example of the relation between risk and return?

source
Image
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: Another look at corporate bonds

Post by larryswedroe »

ANC

Here's the biggest problem with that line of thinking, while individuals still play a significant role in setting equity prices, and that leads to lots of mispricings (which limits to arbitrage can prevent the arbs from correcting), the corporate bond market is almost totally an institutional one. So who exactly are the dummies ANC that you are going to exploit? Who are those suckers at that poker table that somehow you are smarter than and can thus expect to fleece?

As I said, the only place where corporate credit risk has been well rewarded is in those fallen angels where charters force institutions to sell, and all at once, and that can provide a buying opportunity. It's also really bad for a mutual fund that limits its holdings to investment grade because they too suffer the market impact costs and it's one reason why corporate credit risk has not been rewarded

It's important to always remember in the pre cost zero sum game you have to be able to identify the suckers you can exploit. Otherwise should not be playing
Larry
Tier1Capital
Posts: 185
Joined: Sun Apr 03, 2011 5:27 pm

Re: Another look at corporate bonds

Post by Tier1Capital »

4) Corporate bonds are still, darn it all, bonds, not stocks, and a 10% drop isn't the same as a 50% drop

This.

Was the fixed income (sub?) asset class up or down during 2008-09? This is certainly one relevant question, but to me the answer isn't binary. I want to also understand the magnitude of any drawdown. My next comment might be considered Boglehead heresy, but I don't need my entire fixed income portfolio to perform act like Treasuries. In my lifetime, there are enough examples where HY corporate, EM bond, long IG corporate and other areas of fixed income have matched or outperformed equities over long periods of time, that I own some of these dreaded fixed income asset classes. Intellectually and academically, this might be concluded as a bad idea, but the returns and diversification work for me.

For anyone concerned, my portfolio is generally Boglehead approved, so I haven't completely sold my soul. :D
kolea
Posts: 1322
Joined: Fri Jul 11, 2014 5:30 pm
Location: Maui and Columbia River Gorge

Re: Another look at corporate bonds

Post by kolea »

larryswedroe wrote: It's important to always remember in the pre cost zero sum game you have to be able to identify the suckers you can exploit. Otherwise should not be playing
Larry
I am not sure I understand this. My thinking must be way off, but I thought I was making a loan when I buy a bond. Not sure where the zero-sum game comes into play.

I pay very little attention to the total return and focus almost entirely on distribution return: (annual distributions) / (amount originally paid for the bond). That return is dependent solely upon distributions (in dollars) and does not vary with price volatility. Of course I am retired so income generation drives a lot of my investment thinking.
Kolea (pron. ko-lay-uh). Golden plover.
User avatar
siamond
Posts: 6003
Joined: Mon May 28, 2012 5:50 am

Re: Another look at corporate bonds

Post by siamond »

nisiprius wrote:1) Corporate bonds have meaningfully more risk than government issues, but it still not comparable to the risk of stocks
2) Corporate bonds have meaningfully more return than government issues, but it's "meaningful," not "huge"
Well, this was my perception too, but running the numbers show that those differences aren't quite meaningful. If you ignore the bizarre numbers in the very first decade tracked by SBBI (1926-1935), the returns are remarkably identical, and the standard-deviations of the 60/40 portfolios I analyzed only differ by 0.3% (can't really call it 'risk' at this level).
nisiprius wrote:3) Corporate bonds are said to have "equity risk" because, as illustrated by 2008-2009, it shows up at the same time as equity risk
4) Corporate bonds are still, darn it all, bonds, not stocks, and a 10% drop isn't the same as a 50% drop
5) Investment-grade corporate bonds are investment-grade bonds, and they are nowhere near as risky as junk ("high-yield") bonds.
Yes, this is what strikes to the core to it imho. Even if points 4) and 5) clearly show that point 3) isn't that dramatic, still point 3) is disturbing (and is a repeat pattern, 2008 is only one case in point). And then, in view of the very similar returns and slightly larger std-deviation, I can understand why Larry and yourself are very skeptical about this vehicle.

Personally, I'm choosing to stick to VBILX because I like the idea of such 50/50 diversification at a time where the expected returns of government bonds seem especially dire. Risk has little to do with short-term volatility, in my book. I find it extremely hard to invest in a vehicle like Vanguard Intermediate-Term Treasury Fund Admiral Shares (VFIUX) with its SEC yield of 1.03% (ah come on!). While Vanguard Intermediate-Term Bond Index Fund Admiral Shares (VBILX) does come with a slightly more reasonable yield of 1.93%. At some point, one has to acknowledge that swimming with a dead weight isn't exactly safe for one's long-term health. Still, I do agree that history isn't quite re-assuring for making such a choice, and at the end this will probably make little difference.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: Another look at corporate bonds

Post by larryswedroe »

koka, was reference ANC's comments about a smart active manager.

tier1

RE bonds being bonds. yes that is true but basically irrelevant. What matters are the source of the risks. What we know is that as you go down grade you are gaining more exposure to the risk of equities--the correlation with stocks rises. So at investment grade should probably count about say 10-15% of the exposure as STOCKS (depending on how high the investment grade), then as you go down grade you should account for more of the risk as equity, with junk perhaps being 50%. If you do that at least you are accounting for the risks. Now of course the problem is that the equity exposure is time varying, with it increasing at exactly the wrong time.

Here's a simple example to demonstrate the point, say you buy a convertible bond that is way in the money, basically it will act just like a stock regardless of the fact that it's a bond. Well non convertibles also have equity risks, just not called equity but it correlates with it. And that includes liquidity premiums/risk as well. And of course that risk shows up at the wrong time.

Larry
lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 10:55 pm

Re: Another look at corporate bonds

Post by lack_ey »

The problem with giving up the quantitative analysis and running things through the lens of 2008-2009 is that 2008-2009 only happens once and similar events aren't necessarily that common. Every market downturn is different; furthermore, a financial crisis has different characteristics on average than the non-financial crisis drops. Also, I think people focus too much on downturns in general and don't give enough focus to what happens between them. All of the behavior matters. Now, the future behavior won't match all of the past either, just as it won't mirror 2008-2009, but the view is probably a little clearer, less biased, and less anecdotal taking the longer slog through history.

Of course, a lot of the times you may end up drawing the right conclusions from that, just maybe not for the right reasons.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: Another look at corporate bonds

Post by nedsaid »

larryswedroe wrote: As to personal experiences, they are anecdotes, not evidence since they cannot be replicated by others (unless were passive in index or similar funds).
And we don't even know if the anecdote is accurate, nor whether all costs and risk-adjustments have been made.
That is a common line to dismiss people that you disagree with: well, what you are saying is anecdotal and therefore is invalid. It is as if personal experience is completely invalid. The problem is that there would be very little on this forum that would be of interest. Pretty much quant guys arguing with each other over statistics, ratios, graphs. Narrative or telling a story is what makes this stuff interesting, you can learn a lot from real life experience with real life money put into real life investments.

Bill Bernstein is a compelling author because he tells a story and uses it as a context within which to weave pertinent facts and statistics. He actually is a very good market historian. Seeing investing within the sweep of human history makes it very interesting. Otherwise, we would have just a very dry recitation of facts. Pretty much, history is a series of many, many anecdotes woven into a much larger story. It is what puts meat on the bones, so to speak.

My response is that anecdotes, while imperfect, are important. You hear enough of them that sound similar, you say to yourself: hmmm, there might be something here. To just dismiss what people are trying to say is. . .well. . .kind of insulting.

What you do is look at the things people are trying to say and look at the evidence. Often we find that evidence is in the eye of the beholder. For example, Larry believes in factor investing. I agree with him because it is in line with my personal observations about market behavior and what I have learned over the years. The academic research resonated with my experience. The thing is, that not everyone accepts the academic research and dismisses it as data mining and cherry picking time periods while pointing out that reliable market data doesn't go back that far. There is also a difference between what academics say what worked in the past and what investors could actually have invested in. How many small/value funds were available in 1929? Probably zero.

Let me raise this question. It is directed at me as well as at others. Do I believe the academic research because I want to believe it?

Following Larry's line of reasoning, if academic research seems consistent with my experiences and with what I knew or suspected, then I should have a bias towards rejecting it and not accepting it. Because it resonated with me, I should reject it. What I knew, thought I knew, or suspected was supported by observations and experiences (a series of anecdotes). I would tend to accept evidence consistent with previous experience and reject evidence that is not. Perhaps I am being more emotional and less rational than I would think.

Don't be so dismissive of people's stories and experiences.
A fool and his money are good for business.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: Another look at corporate bonds

Post by nedsaid »

Larry wrote a very fine article. Probably the biggest risk he raised with corporate bonds is the lack of liquidity in many parts of the bond market. This is a much underrated risk as I think that a short term bond panic could happen and certain bonds would be more volatile than they have been historically. I have had this discussion with my independent broker and he says that liquidity in the corporate bond market is pretty hit and miss and it isn't always where you would think. There is no question about the liquidity of nominal treasury bonds. Liquidity risk is pretty much overlooked today.

Another thing that has helped treasuries is the flight to quality aspect when things go wrong in markets.

A weak point of the article was that Larry compared 20 year treasuries with 20 year corporates. It was a weak point because probably the great majority of Bogleheads invest in the shorter and intermediate parts of the market. What 20 year bonds do in different market conditions is not too relevant to me as I invest in the Intermediate range of the market probably 5 to 8 years or so. There are few recommendations here for investing in long term bonds.

I invest in a Diversified Bond Fund at my favorite mutual fund company. Its one, three, five, and ten year returns are 5.6%, 3.86%, 3.68%, and 5.25%. Compare that to a US Government Fund that invests in treasury and agency bonds with one, three, five, and ten year returns of 4.84%, 2.93%, 2.70%, and 4.57%. Diversified Bond owns Corporates and the US Government fund does not though Diversified Bond still owns good helpings of US Government Treasury and Agency bonds. I am willing to accept the slightly higher volatility for the higher returns. Not only that, the Diversified Bond fund has a 0.13% higher expense ratio. So just eyeballing the two funds, I would rather be in the higher returning fund as the extra volatility was not very much, even in 2008-2009. This type of eyeballing might be the type of thing that Trader/investor is seeing.

Really what Larry is saying is that the extra returns from corporates over treasuries are probably not worth the extra risk you are taking. It is interesting that John Bogle takes a more sanguine view towards corporates than Swedroe.
A fool and his money are good for business.
Topic Author
larryswedroe
Posts: 16022
Joined: Thu Feb 22, 2007 7:28 am
Location: St Louis MO

Re: Another look at corporate bonds

Post by larryswedroe »

nedsaid
First, I used 20 year maturity because that is how the TERM premium is calculated in finance. Not as a data mining choice. Note as I have that at shorter maturities you add the options of CDs which clearly have significantly higher yields than Treasuries and make things stronger for not including corporates. Also I have noted that the academic literature on the subject finds what I have said, the only place it has been well rewarded is in fallen angels. Again, not my opinion.

Second, re the issue of anecdote. I strongly disagree because in the case of the example given we have no evidence of actual facts--what were the alternatives that could have been purchased such as CDs to compare to. The writer made no statement about any comparisons, no risk-adjusted returns within portfolios, etc. Now if you can produce that over long period at least you can have comparables. But you don't have anything more than one sample, one that could not be repeated unless it was systematic approach (which this was clearly not). And without those two you have nothing more than one data point which is literally meaningless in the same way that someone points out that they chose manager X 20 years ago and that manager beat the market. Well how many others using the same principles chose a different manager?

Hope that is helpful
Larry
Tier1Capital
Posts: 185
Joined: Sun Apr 03, 2011 5:27 pm

Re: Another look at corporate bonds

Post by Tier1Capital »

I'll make another attempt on my view of corporate bonds vs. stocks. The focus seems to be most about timing and correlation, so basically corporate bonds tank when equities do -- at exactly the wrong time. I agree about timing timing and the common direction of returns, and also the reason for the correlation being the common risk factor embedded in both equities and corporate bonds. I personally don't feel this discussion is complete without some focus on the magnitude of the drawdowns during market stress. Maximum drawdowns (2007-10): S&P 500 57%, HY corp 34%, IG corp 12%. Those are all negative, but materially different and consistent in reflecting the risk of owning equity and high/lower risk corporate debt, debt that's by definition at a higher spot in the capital structure vs. corporate equities. The drawdowns are in logical order and quite frankly, an expected outcome. Combine these drawdowns with chunks of time where equities either underperform, or just meagerly outperform bonds, and it's enough for me to own some corporate bonds among other fixed income risk offerings. One view of the world is simply to offset equity risk by owning Treasuries. Another view is you can lighten up on Treasuries by owning securities that don't fall like equities when markets puke.

I'm borrowing Taylor's line here but many roads to Dublin.
lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 10:55 pm

Re: Another look at corporate bonds

Post by lack_ey »

larryswedroe wrote:nedsaid
First, I used 20 year maturity because that is how the TERM premium is calculated in finance. Not as a data mining choice. Note as I have that at shorter maturities you add the options of CDs which clearly have significantly higher yields than Treasuries and make things stronger for not including corporates. Also I have noted that the academic literature on the subject finds what I have said, the only place it has been well rewarded is in fallen angels. Again, not my opinion.
Why does the literature generally not adjust by duration rather than maturity for this comparison? The term risk in a 20-year corporate is lower than the term risk in a 20-year Treasury because the former has a higher coupon. If examining the contribution of credit risk and isolating other effects, you would ideally keep (option-adjusted) duration constant, no?
stlutz
Posts: 5585
Joined: Fri Jan 02, 2009 12:08 am

Re: Another look at corporate bonds

Post by stlutz »

Why does the literature generally not adjust by duration rather than maturity for this comparison? The term risk in a 20-year corporate is lower than the term risk in a 20-year Treasury because the former has a higher coupon. If examining the contribution of credit risk and isolating other effects, you would ideally keep (option-adjusted) duration constant, no?
Here is another thread where we discussed this very subject (with reference to a paper from AQR):

viewtopic.php?f=10&t=194573
stlutz
Posts: 5585
Joined: Fri Jan 02, 2009 12:08 am

Re: Another look at corporate bonds

Post by stlutz »

Hi Larry,

Currently the option-adjusted spread for BBB corporates is 1.97% (https://fred.stlouisfed.org/series/BAMLC0A4CBBB). At what spread would you currently consider corporate bonds to be "worth it"?

My understanding is that you are simply pointing out that investors have not been rewarded adequately for credit risk in the past. But there has to be a level where your view would change--am I right?
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: Another look at corporate bonds

Post by nedsaid »

larryswedroe wrote:nedsaid
First, I used 20 year maturity because that is how the TERM premium is calculated in finance. Not as a data mining choice. Note as I have that at shorter maturities you add the options of CDs which clearly have significantly higher yields than Treasuries and make things stronger for not including corporates. Also I have noted that the academic literature on the subject finds what I have said, the only place it has been well rewarded is in fallen angels. Again, not my opinion.

Nedsaid: It was interesting that I passed on your recommendation for CDs purchased on the secondary market to someone who sent me a personal message. He then sent me a quote from Vanguard brokerage which showed about a 3% bid/ask spread and a 0.1% commission. Neither should have surprised me but I found the cost of buying these was more than I realized. How much of a spread is normal for brokered CDs? How much more yield can you get on the secondary market vs. buying direct?

Most people look at fund returns and don't do detailed statistical analysis. I eyeball things and can't help but notice certain things. The Vanguard Intermediate Term Investment Grade fund returned 6.09% over 10 years and Intermediate Term Treasury over the same period returned 5.30%. I went to T. Rowe Price and found very similar results comparing similar funds. At Vanguard, that is a difference of 79 basis points. It could be that the extra return wasn't worth the extra volatility as corporates were down about 10% or so in 2008-2009 and treasuries were up. But for me, with a little more patience and a little more willingness to wait things out, the extra return would be worth it. The data comes right off the Vanguard website. This is the type of stuff that Trader/Investor sees and he can't help but notice.

Your point about CDs is well taken and in the future will consider these.


Second, re the issue of anecdote. I strongly disagree because in the case of the example given we have no evidence of actual facts--what were the alternatives that could have been purchased such as CDs to compare to. The writer made no statement about any comparisons, no risk-adjusted returns within portfolios, etc. Now if you can produce that over long period at least you can have comparables. But you don't have anything more than one sample, one that could not be repeated unless it was systematic approach (which this was clearly not). And without those two you have nothing more than one data point which is literally meaningless in the same way that someone points out that they chose manager X 20 years ago and that manager beat the market. Well how many others using the same principles chose a different manager?

Nedsaid: Trader/investor should have given examples but again when you eyeball data and graphs, you just can't help but notice certain things. If you add investment grade corporates to a treasury portfolio, from what I can see you will add more return albeit at more risk. I have seen this at three mutual fund companies and I could check more if you would like. The question really is if the extra return is worth the extra risk. Probably where you are on the yield curve affects this. I suppose on the mid to short term, a fair comparison would be with FDIC Insured CDs, and that is a good point. That is a good comparison to a risk-free investment.

The thing is that research starts with observations. A statement would be made such as "over long periods of time the market has a small and value premiums." Somebody probably eyeballed historical graphs and data and wondered if such premiums existed. Maybe it was a hunch. A feeling. Then a theory would be formulated to explain the premium if indeed it exists. Then there is an exhaustive study of whatever historical data exists (and there is some doubt how far back this goes) to prove whether or not such factors exist. The data is examined over and over again and in different ways to see if the results can be replicated. If you didn't have anecdotes, there would be nothing to start from. You have to have observations to begin with.

It isn't like I am just tossing out random phrases and seeing if something will stick. I am not just making stuff up when I post. I own investments and watch how they perform under different market conditions. I can't help but draw some conclusions from what I see and what I experience. Good grief, is that a crime? Then I do some checking to see if I am right. It could be that a certain effect has a different cause than what I had perceived. That is where the research really helps as it has refined my thinking and provides more depth.

Can I look at data and come to my own conclusions? Am I supposed to suspend all judgment and disbelieve what my eyes and ears tell me? Should I just throw all of that out and seek the seal of approval from approved academics? Can I actually do my own thinking?

Hope that is helpful
Larry
A fool and his money are good for business.
Tanelorn
Posts: 2366
Joined: Thu May 01, 2014 9:35 pm

Re: Another look at corporate bonds

Post by Tanelorn »

larryswedroe wrote:Salty
CD spreads are typically 30-60bp more than Treasuries, and often more than that. And many also come with very low early redemption which corporates don't. And given the pre expense premium has been under 30bp and trading costs have to be included, let alone the ER of the fund you need, think it's safe assumption.

As to personal experiences, they are anecdotes, not evidence since they cannot be replicated by others (unless were passive in index or similar funds).
And we don't even know if the anecdote is accurate, nor whether all costs and risk-adjustments have been made.

all my data comes from a returns program provided by DFA
Larry's article wrote:However, corporate bonds do entail credit risk; thus, diversification is the prudent strategy. And that requires the use of a mutual fund. Even low-cost mutual funds and ETFs can cost 10 to 20 basis points, wiping out much of the slim premium corporate bonds have earned. Because the trading costs for corporate bonds are also higher than they are for Treasurys, the realizable premium would be even slimmer, if there was any premium remaining at all.
Larry - I wondered from your above comment and that from article whether the historical returns for the corporate bonds you discussed included either:

1. Any expense ratio for an investment vehicle, or
2. Trading costs for maintaining the portfolio

I also wonder, in the context of looking at investments' marginal contribution to a portfolio as a whole, whether corporate bonds might have a place in a more conservative portfolio that elected to not hold equities. I can see they are a less good diversifier of equity risk, but if your portfolio didn't need that, perhaps these bonds would add some incremental return to an otherwise very safe treasuries / CDs style portfolio.

Thank you.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: Another look at corporate bonds

Post by nedsaid »

Essentially Larry, what I have been trying to say is that I believe the academic research because it passes the smell test. It just makes sense to me.

If the research told me to chase performance, that expensive beats cheap, and to always buy the highest yielding bonds, I would have dismissed it as complete B.S. no matter how many PhDs in finance said it was so. Such conclusions would not have passed the smell test. It would have been counter to everything I observed, learned and experienced. From that aspect, anecdotes are important. They give you a place to start.

It is like saying that the odds of getting struck by lightning are very, very low. But if I indeed got struck by lightning and lived to tell about it, my story would be worth listening to though the odds of it happening were very low. If it happened to me, the probability is 100%! I wouldn't listen to all the Math PhDs that told me that a lightning strike could not have happened. I supposed singed hair or burns might convince them.

If somebody tells me something and it seems believable though not likely, I will listen and try to get something out of it. Obviously, I will do my best to check if the person checks out as a credible source, if their statements are consistent, and if whatever facts they cite actually can be verified.
A fool and his money are good for business.
lack_ey
Posts: 6701
Joined: Wed Nov 19, 2014 10:55 pm

Re: Another look at corporate bonds

Post by lack_ey »

nedsaid wrote:Let me raise this question. It is directed at me as well as at others. Do I believe the academic research because I want to believe it?
Based on the other responses, I would say that your approach (which is common and also applied to other things like quotes from famous people) as stated uses research only to affirm one's existing preconceptions, not as much to challenge them, so the inclination is to just pick up on whatever sounds right.

I think this is a poor way of learning about the world and dangerous for effective decision making. Of course, in general one can still be right but for the wrong reasons.

Anecdotes and personal experience are usually weak for a number of reasons. They are frequently poorly documented. Even when not, and you're taking anecdotes from a great deal of sources, even a large sample size may not move you closer to the truth. It's easy for these to be systemically biased, and when you average a number of biased results, you can end up with distorted conclusions. i.e. the "noise" is not necessarily and is frequently not random

Research and academic inquiry can be biased, and data sets can have their problems, but these can be adjusted and somewhat compensated for. You can throw bad data out. The starting point, in the very least, is consistent when different people talk about it, rather than people drawing on different personal experiences. Many or most papers are flawed; you have to consider the body of work as a whole.

Generally if what someone thinks is different from what the research suggests, it's probably the person that's wrong. Not always, of course.

Though for finance in particular, talking about publicly traded securities, anybody's given experiences are already part of the data set. All an anecdote does is overemphasize a limited segment of data at best. If you want to know about how US stocks did the last 30 years, you don't ask an active stock trader with 30 years of experience what their record was like. Even if they have it all correctly documented, what they experienced was different from what the market did anyway, and we can just check the data on that.
User avatar
saltycaper
Posts: 2650
Joined: Thu Apr 24, 2014 8:47 pm
Location: The Tower

Re: Another look at corporate bonds

Post by saltycaper »

larryswedroe wrote:
Salty
CD spreads are typically 30-60bp more than Treasuries, and often more than that. And many also come with very low early redemption which corporates don't. And given the pre expense premium has been under 30bp and trading costs have to be included, let alone the ER of the fund you need, think it's safe assumption.
Probably safe, but I wonder what the breakeven point would be. Perhaps it's easier to exclude corporate bonds for a moment, and consider what spread over Treasuries might have been required in the past to give CDs the edge. No roll yield potential compared to Treasuries. No flight to quality benefit. Would you hazard a guess as to what the CD yield would have to be in order to be a better deal than Treasuries of comparable duration? Even if we simplify and ignore the benefit of the put option of CDs, the potential negative of not getting some interest in the event of a bank failure, and assume no trading costs or expenses?

Does anyone else have a spread in mind that makes them prefer CDs? How about when comparing CDs to the SEC yield of a corporate bond fund?
larryswedroe wrote:
As to equity risk. Yes they have equity risks, that's just terminology, the risks relate to equities and that is simple basic finance 101, and the research confirms the theory.

As Martin Fridson explained in his 1994 paper “Do High-yield Bonds Have an Equity Component?”: “In effect, a corporate bond is a combination of a pure interest rate instrument and a short position in a put on the issuer’s equity. The put is triggered by a decline in the value of the issuer’s assets to less than the value of its liabilities, resulting in a default — putting the equity to the bondholders. For a highly-rated company, the put is well out of the money and is not likely to be exercised. The option consequently has a negligible impact on the price movement of the bonds, which is more sensitive to interest rate fluctuations. In the case of a high-yield bond, however, default is a realistic enough prospect to enable the equity put to affect the bond’s price materially. With the equity-related option exerting a greater influence on its price movement, the high-yield bond will track government bonds (pure interest rate instruments) less closely than the investment-grade bond does.”
Ah, yes. I knew this sounded familiar. I first read the theory in the excellent debate between you and Rick Ferri in What is the consensus on High Yield Bond Funds?
Quod vitae sectabor iter?
User avatar
saltycaper
Posts: 2650
Joined: Thu Apr 24, 2014 8:47 pm
Location: The Tower

Re: Another look at corporate bonds

Post by saltycaper »

nisiprius wrote:
I really am baffled by all the love corporate bonds have been getting lately, although I think part of the answer lies in the five-year returns at October-2008-plus-five-years. I swear that people were impressed by the five-year returns and ignoring the fact that a lot of those returns just amounted to climbing out of a hole that Total Bond and treasuries never fell into.
Yes. I too think the recent past is skewing investors' preferences for corporate bonds, especially junk bonds.

nisiprius wrote:
Anyway, it really seems pretty clear to me that

...

3) Corporate bonds are said to have "equity risk" because, as illustrated by 2008-2009, it shows up at the same time as equity risk

...
I agree they do, but I don't think you can claim this based on the chart. If you plotted TIPS, obviously you wouldn't say they have equity risk, but it would look like they do! IOW, just because corporate bonds and stocks become more correlated doesn't mean the reason was due to equity risk, even if that was the case in 2008-09.
Quod vitae sectabor iter?
Trader/Investor
Posts: 264
Joined: Wed Dec 02, 2015 8:35 pm

Re: Another look at corporate bonds

Post by Trader/Investor »

saltycaper wrote:
nisiprius wrote:
I really am baffled by all the love corporate bonds have been getting lately, although I think part of the answer lies in the five-year returns at October-2008-plus-five-years. I swear that people were impressed by the five-year returns and ignoring the fact that a lot of those returns just amounted to climbing out of a hole that Total Bond and treasuries never fell into.
Yes. I too think the recent past is skewing investors' preferences for corporate bonds, especially junk bonds.

nisiprius wrote:
Anyway, it really seems pretty clear to me that

...

3) Corporate bonds are said to have "equity risk" because, as illustrated by 2008-2009, it shows up at the same time as equity risk

...
I agree they do, but I don't think you can claim this based on the chart. If you plotted TIPS, obviously you wouldn't say they have equity risk, but it would look like they do! IOW, just because corporate bonds and stocks become more correlated doesn't mean the reason was due to equity risk, even if that was the case in 2008-09.

Yes. I too think the recent past is skewing investors' preferences for corporate bonds, especially junk bonds.

So far removed from reality. That is what happens when the academics take over with their biased research and who have probably never traded/invested in a junk bond fund in their investing lifetime. Have you checked the returns of junk bond funds during the 80s and 90s???? Not exactly chopped liver. And the recent past??? 2014 and 2015 were really poor years for junk corporate bonds. But why should I complain? I love the word "junk" because it scares off investors to that category. So many exploitable inefficiencies in the open end such as the one day lag vs. the junk ETFs and the late day pop pattern in the ETFs vs. the open end to name just a few. And let's not even get into trading/investing in the junk munis. Another overlooked market.


Edit: I swear that people were impressed by the five-year returns and ignoring the fact that a lot of those returns just amounted to climbing out of a hole that Total Bond and treasuries never fell into.

More science fiction. Junk bonds recouped their 2008 losses by August 2009 trading at all time highs and closed out 2009 with gains in excess of 40%.
Last edited by Trader/Investor on Sun Jul 17, 2016 12:04 am, edited 2 times in total.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: Another look at corporate bonds

Post by nedsaid »

lack_ey wrote:
nedsaid wrote:Let me raise this question. It is directed at me as well as at others. Do I believe the academic research because I want to believe it?
Based on the other responses, I would say that your approach (which is common and also applied to other things like quotes from famous people) as stated uses research only to affirm one's existing preconceptions, not as much to challenge them, so the inclination is to just pick up on whatever sounds right.

Nedsaid: I don't think that is fair. I have read literature that favors indexing and literature that favors factors and tilting. Pretty much I have advised people to tilt if they believe in the academic research and use the 3-5 fund Taylor Larimore portfolio if they don't. I have read Bogle's Telltale Chart speech and it is compelling. I have pointed out the possible flaws in the "factors" approach as opposed to pure indexing. I have posted both sides of the argument. It boils down to schools of thought, differences in philosophy. I happen to come down on the side of the academics.

There are good reasons to be skeptical of what your "betters" tell you. I remember the programmed learning modules introduced in 6th grade based on research based on the work of B.F. Skinner. The learning modules were elementary and simple and had a certain pattern to them that was easy to figure out. Me and my classmates just breezed through the learning modules and I thought the whole thing was bunk. 6th graders are certainly smarter than Skinner's pigeons and probably smarter than Skinner. He had a great idea, programmed learning, and it had validity. The problem was that he thought it was the only thing and trying to apply one idea to everything just didn't work. It was just a fad, experienced educators should have known better.


I think this is a poor way of learning about the world and dangerous for effective decision making. Of course, in general one can still be right but for the wrong reasons.

Nedsaid: I don't think that is fair. There are certain things that cannot be explained to the people who are more quantitative in their thinking. Investing is not just an engineering problem to be solved or a formula to be solved. Certainly, analyzing numbers is huge when it comes to investing but it isn't the whole thing. Investing has a huge behavioral element in it too, numbers based on historical data can very accurately describe what happened in the past but doesn't work as well projected out into the future.

You are also assuming that I only get my information from sources that I like or agree with and that I don't consider other points of view.

The thing is that I have emphasized over and over that anecdotes and personal experience are a starting point. I have never said that they are the whole thing and I have never said to ignore the evidence or disregard everything one disagrees with. I thought I had made that clear but apparently not.


Anecdotes and personal experience are usually weak for a number of reasons. They are frequently poorly documented. Even when not, and you're taking anecdotes from a great deal of sources, even a large sample size may not move you closer to the truth. It's easy for these to be systemically biased, and when you average a number of biased results, you can end up with distorted conclusions. i.e. the "noise" is not necessarily and is frequently not random

Nedsaid: I am also aware that statistics can be used to obfuscate and not just illuminate. There are people smarter than I who believe in the smell test. There are things that are asserted by those with authority and credentials that just don't make sense. Just think of all the studies on human health that have generated conflicting results. One study says coffee is bad for you and a few years later another comes out that says coffee is good for you. I saw that many studies have been rerun where researchers could not replicate the results of the original. This happens more often than one would think.

You have to look at the weight of the evidence. If you get study after study that says the same thing and there is integrity in their processes, it would be wise to at least consider what is being said. We all know that there are studies out there that are just outliers. But if study after study keeps saying the same thing, at some point you can't say that it is bad data or researcher bias. The weight of the evidence might cause someone to change their mind.

It is like hotel reviews on the internet. I read what people have to say knowing full well that there are the chronic complainers. No matter how clean the hotel is, how great the staff, and how fantastic the food, certain people will always say everything was terrible. Again, looking at the weight of the evidence and knowing that there are outliers.


Research and academic inquiry can be biased, and data sets can have their problems, but these can be adjusted and somewhat compensated for. You can throw bad data out. The starting point, in the very least, is consistent when different people talk about it, rather than people drawing on different personal experiences. Many or most papers are flawed; you have to consider the body of work as a whole.

Nedsaid: I agree with that. No research is perfect and we can't 100% rid ourselves of biases. It is what it is.

One example of this is Dr. Wade Pfau. I like him and his work but one has to take into consideration that his research is funded by the insurance industry. He has received a fair amount of bashing here for that. I say read what he has to say and do your best to separate the wheat from the chaff.


Generally if what someone thinks is different from what the research suggests, it's probably the person that's wrong. Not always, of course.

Nedsaid: The problem is that there gets to be an orthodoxy out there that isn't supposed to get challenged. I have always said that a bit of contrarian thinking is beneficial to an investor. But certainly I read the research and have made changes based on it.

Though for finance in particular, talking about publicly traded securities, anybody's given experiences are already part of the data set. All an anecdote does is overemphasize a limited segment of data at best. If you want to know about how US stocks did the last 30 years, you don't ask an active stock trader with 30 years of experience what their record was like. Even if they have it all correctly documented, what they experienced was different from what the market did anyway, and we can just check the data on that.
Last edited by nedsaid on Sun Jul 17, 2016 12:22 am, edited 1 time in total.
A fool and his money are good for business.
User avatar
nedsaid
Posts: 19249
Joined: Fri Nov 23, 2012 11:33 am

Re: Another look at corporate bonds

Post by nedsaid »

Trader/Investor wrote:
saltycaper wrote:
nisiprius wrote:
I really am baffled by all the love corporate bonds have been getting lately, although I think part of the answer lies in the five-year returns at October-2008-plus-five-years. I swear that people were impressed by the five-year returns and ignoring the fact that a lot of those returns just amounted to climbing out of a hole that Total Bond and treasuries never fell into.
Yes. I too think the recent past is skewing investors' preferences for corporate bonds, especially junk bonds.

nisiprius wrote:
Anyway, it really seems pretty clear to me that

...

3) Corporate bonds are said to have "equity risk" because, as illustrated by 2008-2009, it shows up at the same time as equity risk

...
I agree they do, but I don't think you can claim this based on the chart. If you plotted TIPS, obviously you wouldn't say they have equity risk, but it would look like they do! IOW, just because corporate bonds and stocks become more correlated doesn't mean the reason was due to equity risk, even if that was the case in 2008-09.

Yes. I too think the recent past is skewing investors' preferences for corporate bonds, especially junk bonds.

So far removed from reality. That is what happens when the academics take over with their biased research and who have probably never traded/invested in a junk bond fund in their investing lifetime. Have you checked the returns of junk bond funds during the 80s and 90s???? Not exactly chopped liver. And the recent past??? 2014 and 2015 were really poor years for junk corporate bonds. But why should I complain? I love the word "junk" because it scares off investors to that category. So many exploitable inefficiencies in the open end such as the one day lag vs. the junk ETFs and the late day pop pattern in the ETFs vs. the open end to name just a few. And let's not even get into trading/investing in the junk munis. Another overlooked market.
Nobody is saying that you can't get good returns from High-Yield Bonds. What they are saying is that such bonds act much like stocks. You get much closer to equity-like returns with High-Yield than other types of bonds but you take equity-like risks to get those returns. The way of thinking about it is the amount of return you receive for each unit of risk. If you get nearly stock like returns from
phony stocks (High Yield) why not get the real thing and get equity returns from real equities?

Junk Bonds did great during the 1980's and 1990's but so did US Stocks.

There is disagreement from our own experts whether High-Yield Bonds belong in a portfolio. Larry Swedroe says no. I make his arguments above. Rick Ferri, another respected expert who posts here, says yes. He believes that investors benefit from having a slice of their bonds invested in High-Yield. I don't care one way or the other. I am in the middle camp, I am willing to take a slightly bigger risk for a bit more return with a diversified portfolio of investment grade bonds: Treasuries, TIPS, Corporates, and US Government Agency bonds. I like to stay in the Intermediate Term.

Larry Swedroe is very, very conservative on the bond side. He likes US Treasury only bond portfolios. He isn't fond of Corporates or Agency bonds. So he does not recommend the US Total Bond Market Index. He is of the school of thought that you take your risk on the equity side and that you buy bonds for safety.

It doesn't always happen, but you want investments that will zig while other investments zag. Investments that go up but sometimes at different times. You hope that your bonds will go up during the times that stocks go down. What you are trying to do is to decrease the volatility of a portfolio or smooth out its ride. Of all classes of bonds, Treasuries give you the best diversification benefit. Part of this is the flight to quality phenomenon that occurs during times of crisis.

In the 2008-2009 financial crisis, most bonds went down while stocks were getting killed. Even investment grade corporate bonds and TIPS were down 10% or so. High Yield was hit real hard but not as badly as stocks. The only bonds that zigged while stocks zagged where nominal treasuries and certain US Government Agency bonds like GNMAs. What Larry was trying to communicate is that corporate bonds particularly High Yield, did not give you the diversification benefits when you needed them most.

No one is saying that you can't get good returns from High Yield. It is the amount of return per unit of risk.

The only High-Yield Bonds that I own are in a rather quirky balanced fund that invests in both higher yielding stocks and Hi-Yield Bonds. But that fund is a very small part of my retirement portfolio, maybe 1%.
A fool and his money are good for business.
Post Reply