Fixed Income Charts — November 18, 2020

Is Equity-Credit Diversification Vanishing?

  • The first three charts compare  STOXX equity indices with HY corporate BB credit spreads (inverted, 5Yr point of Qontigo Cluster Curves).
  • Correlations over the longer  HISTORICAL period have been steadily increasing in the three main regions  (correlations use monthly overlapping returns with  5Yr lookback, 6m moving average)
  • Increase in HY issuance as well as higher liquidity through ETFs leading to increased access to markets may help explain why the correlation has increased substantially.
  • The recent Covid crisis pushed correlations to an  all-time historical high over the last 12 years in all three markets: diversification can be elusive when you need it most.
  • Enhancing Fixed Income strategies by taking more credit exposure comes at the price of lower diversification to Equities. This is known (see e.g. “Active Fixed Income Illusions” AQR 2019).
  • We observe that this challenge has become more acute over the years.
  • The last three charts analyze correlations  YEAR-TO-DATE (correlations here  use daily  returns with 3m lookback, 1w moving average).
  • From the peak of the crisis mid March until the end of August  equities and HY credit were strongly  correlated, contributing to the all-time high.
  • Since September we can see a degree of diversification returning. This was also visible in the fact that credit markets did not follow the recent dip and subsequent recovery of equities.
  • Credit spreads are plotted on an inverted scale, so that a rise in the series implies lower yield premia and improving borrowing conditions.

HISTORICAL DEVELOPMENT

Source: Qontigo

YEAR-TO-DATE DEVELOPMENT

Source: Qontigo