Credit Risk Isn’t Worth It
rom 1926 through 2014, the default premium (the annual return on long-term, investment-grade corporate bonds minus the annual return on long-term Treasurys) has been just 0.22 percent. Such a small premium has led many observers, including me, to conclude that investors willing to accept higher levels of portfolio risk in exchange for higher expected returns should seek those higher returns in places other than corporate debt.
In addition to the miniscule realized premium, another problem for holders of corporate debt is that default risk doesn’t mix well with equity risk. The risk of default has a nasty tendency to appear at just the same time the risks associated with owning equities show up.
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