Why investors might be wrong about corporate bonds
Find out how an allocation to corporate bonds can help your portfolio in the current environment of low yields and higher volatility.
The world seems to have become more uncertain and perhaps more precarious for investors over the past year. The fourth quarter of 2018 was a stark reminder of the risks – and pain – of sudden and sharp market declines. The impact was all the more jarring given that investors had previously enjoyed an extended period of highly supportive conditions and almost uninterrupted gains.
In times of uncertainty – when the investment landscape seems to be shifting – assets that can demonstrate diversification benefits, stability and the ability to bounce back from setbacks start to look distinctly appealing. Based on historical behaviour and returns, investment grade (IG) corporate bonds appear to fit the bill.
Related insights: The surprising diversity of bond markets
A history of stable returns
Corporate bonds, bonds issued by companies, are generally thought to provide a level of returns somewhere between government bonds and stocks, but with lower volatility (the degree of fluctuation in returns) and drawdowns (the scale of a market decline from high to low) than stocks. This is partly on account of interest income that bonds generate, which can provide a cushion, mitigating the decline in total returns during tougher market conditions when prices may fall. In this sense, corporate bonds are often said to provide attractive risk-reward characteristics.
The chart below, showing annualised historic returns of global IG corporate bonds from 1996 to 2018, indicates the stability of returns from the asset class over time. It shows the annualised returns an investor would have received from global IG corporate bonds depending on which year they invested, starting from 31 December 1998.
Past performance is not a reliable indicator of future returns, prices of shares or bonds, and the income from them, may fall as well as rise and investors may not get the amount originally invested.
So taking the longest period of time, if an investor invested a chunk of their money in the global IG index as at 31 December 1998 (starting from the vertical axis) and held the investment until the end of 2018 (on the horizontal axis), their return over that time would have amounted to an annualised 4.7%. If the initial investment was made in 1998 and sold in 2017 the annualised return would have been 5.1%, and so on.
Read more about Schroders' credit investing capabilities.
Based on this data, the best point at which to invest would have been, unsurprisingly, the end of 2008, following the decline in that year of -4.7%. The global IG index fell -5.5% in September as Lehman Brothers declared bankruptcy and the credit crisis reached its most heightened stage, followed by a further -4.4% decline in November.
The corporate bond market showed its ability to mitigate against steep losses amid tumultuous market conditions and bounce-back, however, reversing the decline more quickly than stocks. Investing at the end of 2008 would have resulted in a gain of 16.3% in 2009 and maintaining the investment until 2018 would have resulted in annualised returns of 5.5%.
By comparison, the MSCI World equity index (local currency, total returns), declined in value by 40% in 2008, rebounding by over 31% in 2009, and adding another 12% in 2010. But with another setback in 2011, the index did not regain its pre-drawdown level until 2013m while global IG corporate bonds had recovered by mid-2009.
A very similar pattern was seen across the euro (see below) and sterling IG corporate bond and European and UK equity markets. Euro IG declined -3.3% in 2008, before returning 14.9% in 2009 and producing annualised returns of 5.0% from the end of 2008 to the end of 2018. The MSCI Europe declined over 40% in 2008, remaining underwater until 2014.
Sterling IG investors experienced a larger decline in 2008, of -9.1%, but subsequently enjoyed annualised returns of 7.4% through to the end of 2018. The UK stock market declined -28.5% in 2008, recapturing its pre-drawdown level in 2010.
Past performance is not a reliable indicator of future returns, prices of shares and the income from them may fall as well as rise and investors may not get the amount originally invested.
One for the long-run
Another point to note is that investing in global IG at any year-end from 1998 to 2005 would still have resulted in a positive annualised return as at the end of 2008, even with the decline in that year.
Through the dotcom boom and bust in the late-1990s returns were relatively disappointing. Global IG corporate bonds returned just 0.1% in 1999. However, over the following years returns were strong. With an investment made at the end of 1999 , global IG markets earned an annualised return of 7-8% over the next five years. The euro IG market also declined -1.9% in 1999, but investors were not out of pocket for long. Sterling IG too had a lacklustre 1999, returning 0.2%, but outperformed through the early-noughties, returning 9.8% in 2000, and notching up annualised returns of over 8% from 2000 to 2005.
Meanwhile, the MSCI World index – although performing strongly in 1999 as the dotcom boom hit its height – saw three straight years of losses. The global index fell -12.9% in 2000, -16.5% in 2001 and -19.5% in 2002. It did not fully recover form these declines until 2004.
The examples of 1999 and 2008 highlight the fact that purchasing IG corporate bonds following a drawdown has made sense in the past, although past performance is not guaranteed to be repeated. More to the point though, buying and holding IG corporate bonds over time can provide exposure to a highly reliable stream of returns.
 A level of credit rating in general regarded as high quality and carrying lower risk for investors.
Risk associated with bond investing:
A rise in interest rates generally causes bond prices to fall.
A decline in the financial health of an issuer could cause the value of its bonds to fall or become worthless.