Graphic Content – November; corporate bond risk premia are now the lowest ever

Mike Riddell
Written by

28th November 2017

Risk premia on a corporate bond can be broken down into two component parts. The first is the term premium, which relates to the risk premium on an underlying government bond, and is the extra yield that investors require on longer-dated bonds to compensate them for the risk of unexpected moves in inflation or the wider economy, or uncertainty regarding central bank policy (see a previous blog comment here for more). The second, which relates to corporate bonds, is the credit spread, which is the extra yield that investors require to compensate them for risk of default and illiquidity. Adding these together provides a measure of overall risk premium.

The blue line in the chart below plots this total risk premium on 10-year US corporate bonds, where we have taken the ACM Model on a 10-year US Treasury to determine the term premium, and added the credit spread on a US 7-10 year BBB rated corporate bond index. Incidentally, the correlation between these two measures of risk premia has averaged +0.69 over the last two decades.

The purple line plots the total return from the corporate bond index 1 year forwards. Risk premia have been a reasonable predictor of future returns, and the current record low levels of premia on corporate bonds should therefore serve as a warning.

Graphic Content – November; corporate bond risk premia are now the lowest ever

Investing involves risk. The value of an investment and the income from it may fall as well as rise and investors might not get back the full amount invested.

This is a marketing communication issued by Allianz Global Investors GmbH, www.allianzgi.com, an investment company with limited liability, incorporated in Germany, with its registered office at Bockenheimer Landstrasse 42-44, 60323 Frankfurt/M, registered with the local court Frankfurt/M under HRB 9340, authorised by Bundesanstalt für Finanzdienstleistungsaufsicht (www.bafin.de). This communication has not been prepared in accordance with legal requirements designed to ensure the impartiality of investment (strategy) recommendations and is not subject to any prohibition on dealing before publication of such recommendations. The information contained herein is confidential. The duplication, publication, or transmission of the contents, irrespective of the form, is not permitted.

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