Corporate bonds are safer investments, really….?

By: ispeculatornew
Date posted: 11.26.2008 (4:00 am) | Write a Comment  (3 Comments)

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You have surely heard this, maybe not in a speculative trading account, but in a RRSP or 401K, it is generally recomended to have a portion of your portfolio in “safe investments”. The basic concept is generally explained as having a more risky portfolio when you are young so that over time you will achieve a higher return. Then, as you age, you increase the proportion of safe investments because if a stock market decline or cash occurs, you will not have as much time to make back the losses and thus not as much acceptance for risk.

The general rule is that the proportion of “safe investments” should be roughly equal to your age. Why do I write “safe investments” between quotes in this article? Because in this current crisis, we are learning a lot about investment and it’s creating a lot of questions about investment and how it should be done.

Why? Simply look at the below graph, UYG is an ETF that tracks corporate bonds. To be fair, it tracks high yield bonds. If you look at LQD, which tracks investment grade bonds (higher quality), their performance has been a lot better (-16% YTD). But still, to many, corporate bonds in general were “safe investments” and I hope that you are not reading this after seeing your retirement fund get crushed because you were holding corporate bonds that did not hold true to their objective (i.e. maintaining their value in a declining market environment). Of course, maybe that only occurs in normal market circumstances and indeed the past few months have not been “normal” by any means. But still, it is good to know and we should now stand as warned.

The blue line in the graph is HYG ETF while the red is the Dow Jones Indsutrial index.

But like most investments, the most important is to not panic. Spreads between corporate bonds and treasuries are in many ways at record levels and as the economy gets better, should improve. It’s not as clear for high yield bonds as some of those will without any doubt suffer from some defaults.  Junk bonds (the most speculative bonds out there) currently trade at a yield of almost 19%, a high since such statistics exist. As the Fed and other central banks fight to improve the liquidity of the system, we see an improvement in those lending conditions for corporate companies worldwide.

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