A number of articles were written at the end of 2008 noting that, for the prior 40-year period, stocks had barely outperformed safer bonds.
For the period 1969 through 2008, the S&P 500 Index returned 8.98% and long-term (20-year) Treasury bonds returned 8.92%. Results for both large-cap growth and small-cap growth stocks were even worse. The Fama-French large-cap growth research index returned 8.52%, while the small-cap growth research index returned just 4.73%.
Making matters worse, while producing nearly the same return as long-term Treasuries, the S&P 500 Index experienced far greater volatility. Its annual standard deviation during this period was 15.4%, compared to just 10.6% for Treasuries.
That equities could outperform Treasuries over a 40-year horizon by just 0.06 percentage points (and that’s before implementation costs) surprised many investors, but it really shouldn’t have. No matter how long the horizon, there must be at least some risk that stocks will underperform safer investments.
Another Absent Risk Premium
Another risk premium also failed to appear over this same 40-year period, one that received far less, if any, attention. Specifically, there was no corporate credit risk premium.
From 1969 through 2008, 20-year corporate bonds returned 8.48% a year and underperformed 20-year Treasury bonds, which you’ll recall had returned 8.92%. Having no corporate credit risk premium at a time when there also was no equity risk premium shouldn’t especially have surprised investors either, because corporate bonds are really hybrid securities (a mix of the risks found in stocks and Treasury bonds). In short, they don’t contain all that much unique risk.
However, what may perhaps be more surprising is the following: For the 92-year period of 1926 through 2017, the riskier S&P 500 Index provided a significant return premium over safer long-term Treasuries, outperforming them by 4.62 percentage points (10.16% versus 5.54%). Over the same period, riskier long-term corporate bonds outperformed safer long-term Treasuries, but only by 0.52 percentage points (6.06% versus 5.54%).
Corporate bonds represent a significant fraction of the world’s capital markets. Looking at the Barclays Global Multiverse Index, which essentially encompasses the global fixed-income market, investment-grade corporate bonds account for $11.3 trillion of the $53.6 trillion value of securities included in the benchmark. High-yield corporate bonds represent another $2.5 trillion.
Taken together, this means investment-grade and high-yield corporate bonds make up about 26% of the global fixed-income market. Yet as the following evidence shows, the case for owning corporate bonds, particularly for individual investors, is weak.
Research On The Credit Premium
My colleague, Jared Kizer, chief investment officer for Buckingham Strategic Wealth and The BAM Alliance, examined the data and shows that portfolios owning equities and government bonds already are exposed to the risks corporate bonds provide, rendering corporate bonds redundant in most portfolios. The following is his analysis. (For those interested, you can find Jared’s paper, “Re-Examining the Credit Premium,” on SSRN.)
Barclays remains the best source for virtually all kinds of fixed-income data, certainly for investment-grade corporate bonds and high-yield corporate bonds. Barclays has index data going back to January 1973 for investment-grade corporate bonds, and back to July 1983 for high-yield corporate bonds. Jared used returns data for both indexes, along with index data for global stocks and bonds, to better understand whether either investment-grade or high-yield corporate bonds have improved the risk-adjusted returns of portfolios.
It is important to understand how much higher, historically, investment-grade and high-yield corporate bond returns have been when compared to Treasury bonds of similar maturity. This difference is the credit premium, meaning it represents additional return corporate bond investors have earned in exchange for owning corporate bonds versus safer Treasury bonds.
The following table, taken from Jared’s paper, reports various statistics associated with the investment-grade and high-yield credit premiums going back as far as the Barclays data permit. Barclays began explicitly reporting monthly credit premiums associated with both investment-grade and high-yield corporate bonds in August 1988, so this is the start date.