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Blog > Posts > The Dynamic Nature of Corporate Bonds
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4/18/2012
Last week’s post pointed out the fact that owning corporate bonds (particularly lower-tier investment-grade and high-yield corporate bonds) muddies the interpretation of your asset allocation. The idea is that corporate bonds tend to behave like a combination of high-quality bonds and stocks. However, in reality it’s even more complex than that. At some points, corporate bonds are more like stocks than at other points. The graph below illustrates the point I’m making. It shows non-overlapping 24-month correlations of the returns of investment-grade corporate bonds with the returns of the S&P 500 Index over the period 1974–2010.
The graph shows just how dynamic the relationship is between the stock market and corporate bonds. At points like 2007–2008, the correlation is fairly high. At other points, including the two years just prior to 2007–2008, the correlation was extremely low. This means that corporate bonds have substantial “surprise potential.” You can go through a period where the correlation to stocks is low and corporate bonds are actually doing a good job diversifying stock market risk, only to be surprised by another period where the opposite is true. Unfortunately, a fair number of those surprise periods are likely to occur when you need the diversification benefits of fixed income the most, periods like 2007–2008.
Random Links and Commentary of the Week
Kareem Abdul-Jabbar wrote a column for ESPN last week discussing the financial woes of athletes. He also holds Magic Johnson out as an example of an athlete who has been financially successful in his post-playing career. While Magic has been enormously successful, athletes should generally be cautious at trying to replicate what he has accomplished.
Clearly, in a good number of these cases, financial troubles had more to do with spending habits and bad advice than lack of investment acumen. Nevertheless, most businesses fail, and for every Magic Johnson there are probably 100 other former athletes who ventured into business only to lose some or all of what they had accumulated in their playing careers. If spending habits are kept under control, most professional athletes in the major sports will accumulate wealth most Americans could only dream of. So the problem isn’t accumulating wealth (again assuming spending habits are kept under control), it’s preserving it. Instead of replicating Magic’s approach, they would generally be better served by building low-risk, low-cost and well-diversified investment portfolios, not starting businesses.
Copyright © 2012, Buckingham Family of Financial Services. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site. |
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 | Jared Kizer
Director of
Investment Strategy
BAM Advisor Services
(see bio)
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