By Scott Ronalds
This posting is for the bond geeks in the crowd.
The manager of our Income Fund, Connor, Clark & Lunn Investment Management, recently did the following analysis on corporate bonds.
If you passively buy a portfolio of 5-yr U.S. investment grade corporate bonds today and hold them to maturity, over 45% of your portfolio needs to default before you are worse off compared to a similar portfolio of government bonds. In calculating this, it is assumed that half of the defaults happen in the next year and the recoveries are 30% (i.e. the bond holders get back 30 cents on the dollar in dissolution), which is lower than the long-term recovery average of 40%. The worst 5-year investment grade cumulative default experience over the past 30 years was under 2%. During the depression (1931-35) the default rate was 3.9%.
It points out the extent of the negativity being factored into the outlook for the corporate market. It also highlights why we think the reward/risk balance in the Income Fund is very favourable.