Fixed Income Charts — June 15, 2020

The Corporate Credit Illusion of a Free Lunch

Chart Highlights

  • BBB-rated corporate bonds yield more than AAA-rated ones to compensate for their lower credit quality.
  • Within the Investment Grade spectrum from AAA down to BBB one would expect the volatility of credit spreads to go from lower to higher in order to adjust for increasing yields.
  • Instead, outside of crisis periods, the volatility of credit spreads is roughly the same from AAA down to BBB. This pattern can be observed for USD, EUR, GBP. Beware: Mean-variance optimization, Information and Sharpe Ratios all rely on volatility! (More on how we can address this in Risk measurement and modelling in times of crisis).
  • Is this a “free lunch”? No! Volatility does not capture other risks such the “Falling Angel”, the company’s risk of downgrade leading to loss of its cherished Investment Grade status and dropping out of the index. Read more on this in our recent blog, Is BB the new BBB?.
  • Buckle your belt and use your mouse to navigate the 3D volatility landscape in this week’s fixed income chart. Check for yourself: only during major crises (GFC in 2009 and COVID in 2020) does the volatility show any significant differences in the AAA-BBB range, but not during other periods.

Source: Qontigo, Axioma Fixed Income Spread Curves.