Why Own Corporate Bonds?

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Blues
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Re: Why Own Corporate Bonds?

Post by Blues »

vineviz wrote: Sat Aug 06, 2022 7:05 pm
Blues wrote: Sat Aug 06, 2022 4:45 pm And I don't disagree. But I'm hoping vineviz will explain his stance since sometimes it may appear to contradict itself. (And I am certainly no authority, and simply conducting a "search for the truth" to the extent it is knowable.)
Given a choice, I'll almost always prefer a combination of stocks and Treasury bonds (either TIPS or nominals, as appropriate).

That said, especially on the shorter end of the duration spectrum there are some ways that corporate bonds mirror some characteristics of TIPS. So I try not to be an absolutist or purist about things.
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Re: Why Own Corporate Bonds?

Post by NoRegret »

In a low equity return environment, other strategies may offer similar Sharpe while being less correlated.

Ab initio, credit repayment which is from nominal revenue should be easier in an inflationary environment. The trick is to hedge term risk, e.g. LQDH/HYGH.
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Re: Why Own Corporate Bonds?

Post by djm2001 »

zero_coupon wrote: Sat Aug 06, 2022 12:41 am If corporate bonds perform similar to treasurys mixed with a bit of equities, why own corporates?
The following excerpt from Prof. Sharpe's RISMAT book helped me understand an important difference between corporate bonds and treasury bonds:
William Sharpe, RISMAT, Chapter 7, https://web.stanford.edu/~wfsharpe/RISMAT/RISMAT-7.pdf wrote: In the early days of financial market equilibrium theories, limited data availability led most researchers to use indices of the returns on stocks as measures of the performance of of “the market”. But this was less than ideal. Consider publicly held corporate securities. A company may finance its activities by issuing bonds and stocks. The particular combination utilized should not affect the overall claims of the public on the corporation's earnings. Certainly the market portfolio should include both corporate stocks and bonds held by the public.

But what about government bonds? Some would say that the net public interest in such securities is zero, since a bond held by an investor is his or her asset and the obligation to pay interest and principal is a liability for those who will have to pay taxes in the future to cover such payments. An alternative view is that a government bond represents a claim on the future earnings of taxpayers and hence an investment in their human capital. While each argument has merits, we take the latter position.
In other words, consider who ultimately pays the bond debt.
  • If you buy corporate bonds, it is their stockholders who ultimately hold the debt. If you want the full public claim on the company's earnings, you must therefore hold their stocks and their bonds. You can't just ignore corporate bonds and look only at stocks because the stocks of two otherwise-identical companies will behave differently if one company issues only stocks while the other issues both stocks and bonds. (In particular, the stocks of the company that issues bonds will be priced to account for the risk of the company's debt obligations and resulting cashflow impositions.)
  • If you buy government bonds, it is future taxpayers who hold the debt. If you're retired, it's the younger generation who will be paying most of your bond interest. If you are early in your career, you'll be paying back some of your own bond interest via your future taxes. That said, you can't avoid paying taxes, so is it worth holding government bonds to get some of that interest back in your pocket or not?
How this affects your personal investing choices is up to you, but it's an interesting part of the equation to be aware of.
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
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Re: Why Own Corporate Bonds?

Post by vineviz »

djm2001 wrote: Sun Aug 07, 2022 7:27 am How this affects your personal investing choices is up to you, but it's an interesting part of the equation to be aware of.
Sharpe's quoted views are certainly valid ones, are are broadly accepted.

They don't, offer, offer an investor any help in deciding the question the OP posed in the title: "why own corporate bonds?". Sharpe is making a theoretical/academic point that corporate bonds are certainly part of the global market portfolio.
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Re: Why Own Corporate Bonds?

Post by djm2001 »

vineviz wrote: Sun Aug 07, 2022 8:25 am Sharpe's quoted views are certainly valid ones, are are broadly accepted.

They don't, offer, offer an investor any help in deciding the question the OP posed in the title: "why own corporate bonds?". Sharpe is making a theoretical/academic point that corporate bonds are certainly part of the global market portfolio.
Totally eliminating a class of assets (e.g., high-yield corporate bonds) from the market portfolio requires a good argument -- e.g., lack of access, prohibitive costs, being a negligible percentage, existing intrinsic risk exposure outside the investment portfolio. In the absence of strong justification, an investor should consider owning at least some position in each (positive net supply) asset class. Sure, you can underweight something depending on your personal circumstance. But willfully picking a hard zero allocation policy to an asset class that is relatively cheaply available? That's often just the result of ideological bias. If it's in the market portfolio, you should strongly consider owning it even if not at market weight. That's why Sharpe's arguments apply here.

I'm sure you know all this, so I'm not sure why you tried to claim that Sharpe's argument doesn't offer any help to the question of "why own corporate bonds", especially since you claimed earlier in the thread not to be an absolutist or purist about things. Do you feel that the market portfolio advice is dangerous because it is too often offered without also telling people to also adjust for personal circumstances?
AA = global stocks & bonds @ market weight (~60/40); EF = i-bonds; WR = -PMT(1%, 100-age, 1, 0, 1)
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Re: Why Own Corporate Bonds?

Post by invest2bfree »

zero_coupon wrote: Sat Aug 06, 2022 12:41 am If corporate bonds perform similar to treasurys mixed with a bit of equities, why own corporates?
I think it is based on investor's psychology.

I love corporate bonds.

If you buy it from large cap valued companies and be diversified then they are reasonable safe.

Also Fidelity makes it a breeze to buy.

I have $1.5M worth of them.

They pay me $85,000 dividends a year and give my money back in 21 years.

It is perfect for an IRA or 401k. You exactly know what your return is.

You can buy more bonds with the interest thrown and if you space the bonds then they give you monthly income like a pension.

Warning it can be as volatile as the stock market.

If you focus on the cash flow then you are okay.
36% (IRA) - Individual LT Corporate Bonds , 33%(taxable) - schy, 33%(taxable) - SCHD Dividend Growth
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Re: Why Own Corporate Bonds?

Post by willthrill81 »

djm2001 wrote: Sun Aug 07, 2022 9:19 am
vineviz wrote: Sun Aug 07, 2022 8:25 am Sharpe's quoted views are certainly valid ones, are are broadly accepted.

They don't, offer, offer an investor any help in deciding the question the OP posed in the title: "why own corporate bonds?". Sharpe is making a theoretical/academic point that corporate bonds are certainly part of the global market portfolio.
Totally eliminating a class of assets (e.g., high-yield corporate bonds) from the market portfolio requires a good argument -- e.g., lack of access, prohibitive costs, being a negligible percentage, existing intrinsic risk exposure outside the investment portfolio. In the absence of strong justification, an investor should consider owning at least some position in each (positive net supply) asset class. Sure, you can underweight something depending on your personal circumstance. But willfully picking a hard zero allocation policy to an asset class that is relatively cheaply available? That's often just the result of ideological bias. If it's in the market portfolio, you should strongly consider owning it even if not at market weight. That's why Sharpe's arguments apply here.
There are very good empirical and theoretical reasons to not own corporate bonds of any sort.

Corporate bonds have underperformed a mix of 20% TSM / 80% Intermediate-term Treasuries on virtually every metric. They have default risk, which Treasuries don't. They are exposed to unexpected inflation, which TIPS and I bonds are not.

The market for bonds is comprised of millions of participants, virtually none of whom have identical investment goals, risk tolerance, etc. As such, the argument that just because someone else has determined than a given asset class is appropriate for them does not any way make it appropriate for you.
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vineviz
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Re: Why Own Corporate Bonds?

Post by vineviz »

djm2001 wrote: Sun Aug 07, 2022 9:19 am
Totally eliminating a class of assets (e.g., high-yield corporate bonds) from the market portfolio requires a good argument --
I agree with Sharpe that corporate bonds are board of the global market portfolio.

My point was merely that the fact that the are PART of that portfolio doesn't necessarily imply that every investor - or, indeed, any particular investor - needs to (or should) own them.
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Re: Why Own Corporate Bonds?

Post by willthrill81 »

vineviz wrote: Sun Aug 07, 2022 10:04 am
djm2001 wrote: Sun Aug 07, 2022 9:19 amTotally eliminating a class of assets (e.g., high-yield corporate bonds) from the market portfolio requires a good argument --
I agree with Sharpe that corporate bonds are board of the global market portfolio.

My point was merely that the fact that the are PART of that portfolio doesn't necessarily imply that every investor - or, indeed, any particular investor - needs to (or should) own them.
And by the same token, just because an asset is excluded from something like a 'total bond market' fund, such as TIPS, does not mean that investors should avoid it.
Last edited by willthrill81 on Sun Aug 07, 2022 10:11 am, edited 1 time in total.
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Re: Why Own Corporate Bonds?

Post by bridge2benefits »

Interesting article on this from Larry Swedroe:
https://www.etf.com/sections/index-inve ... nopaging=1
From 1969 through 2008, 20-year corporate bonds returned 8.4% a year and underperformed 20-year Treasury bonds. Having no corporate credit risk premium at a time when there also was no equity risk premium shouldn’t have surprised investors, because corporate bonds are really hybrid securities (a mix of the risks of stocks and Treasury bonds) that don’t have much unique risk.

Now consider the following: For the 92-year period 1926 through 2017, the riskier S&P 500 Index provided a significant return premium over safer long-term Treasuries, outperforming them by 4.7% percentge points a year (10.2% versus 5.5%). Over the same period, riskier long-term corporate bonds also outperformed safer long-term Treasuries—6.1% versus 5.5%.

However, that’s before considering their greater implementation costs.
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Re: Why Own Corporate Bonds?

Post by pyesquared »

I often wonder what the experience is like when holding corporate bonds if the issuer goes insolvent/bankrupt. You can watch stocks crash to near zero, but I guess bond holders eventually have some chance at some form of recovery....eventually.
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Re: Why Own Corporate Bonds?

Post by bsteiner »

Treasury bonds are exempt from state income tax, so they may be more attractive to taxpayers in high tax states. To the extent that's the case, corporate bonds may be more attractive to taxpayers in low tax states and states that don't have a state income tax.

Has anyone analyzed this?
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Re: Why Own Corporate Bonds?

Post by vineviz »

pyesquared wrote: Sun Aug 07, 2022 10:22 am I often wonder what the experience is like when holding corporate bonds if the issuer goes insolvent/bankrupt. You can watch stocks crash to near zero, but I guess bond holders eventually have some chance at some form of recovery....eventually.
Most bond defaults are, indeed, "technical" defaults. Many of them are so inconsequential that an individual invest might not even notice.

For senior secured bonds, the recovery rate (the extent to which lenders can recover the principal and accrued interest on a defaulted bond) averages about 65% or so. An investor could either wait for that process to play out, or (usually) sell the bond at a deeper discount and let someone else deal with it.

Only very large investors can efficiently build a diversified portfolio of individual corporate bonds.
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Re: Why Own Corporate Bonds?

Post by Beliavsky »

Over Jan 1987 - Jul 2022, the optimal portfolio with VFINX, VUSTX, VWESX, VWEHX (high yield corporates) was 28.5% VFINX, 40.8% VUSTX, 30.7% VWEHX, according to Portfolio Visualizer.
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Re: Why Own Corporate Bonds?

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Beliavsky wrote: Sun Aug 07, 2022 11:51 am Over Jan 1987 - Jul 2022, the optimal portfolio with VFINX, VUSTX, VWESX, VWEHX (high yield corporates) was 28.5% VFINX, 40.8% VUSTX, 30.7% VWEHX, according to Portfolio Visualizer.
Only if you define "optimal" as "having the highest ex-post Sharpe Ratio" and only then if you exclude short-term and intermediate-term Treasury bonds, small cap stocks, etc.
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Re: Why Own Corporate Bonds?

Post by Beliavsky »

vineviz wrote: Sun Aug 07, 2022 12:35 pm
Beliavsky wrote: Sun Aug 07, 2022 11:51 am Over Jan 1987 - Jul 2022, the optimal portfolio with VFINX, VUSTX, VWESX, VWEHX (high yield corporates) was 28.5% VFINX, 40.8% VUSTX, 30.7% VWEHX, according to Portfolio Visualizer.
Only if you define "optimal" as "having the highest ex-post Sharpe Ratio" and only then if you exclude short-term and intermediate-term Treasury bonds, small cap stocks, etc.
I excluded some funds since they opened later than 1987. Adding short-term and intermediate-term Treasury bonds and VTSMX (to include small cap stocks), VWEHX still gets 7% weight -- link over the period Jan 1993 - Jul 2022.

In the book Investing Amid Low Expected Returns (2022), Ilmanen cites a 2016 paper by Asvanunt and Richardson and the book Ben Dor, Arik: Albert Desclee: Lev Dynkin: Jay Hyman; Simon Polbennikov (2021), Systematic Investing in Credit to support investing in corporate bonds:
Besides reporting a much higher credit premium than earlier research had, Asvanunt-Richardson
(2017) directly addresses the marginal role of credits in a broader portfolio. When
they regress the credit excess return on Treasury and S&P500 excess returns over their 1936–
2014 sample period, they find a statistically significant regression intercept (alpha). And when
they conduct a mean-variance optimization analysis across the three asset classes, credits were
hardly a redundant asset. Instead, the weight of corporates in the ex-post optimal portfolio was
48% (compared to 35% for Treasuries and 17% for S&P500). Despite its positive (0.25) correlation
with equities, the credit premium has been a useful contributor to investor portfolios.

Ben Dor et al. (2021, Chapter 1) confirm that a credit portfolio has significantly outperformed
a comparable mix of equities and Treasuries (1.5% for IG, 3% for HY between 1993 and
2019) even when they carefully adjust for different company and sector compositions in equity
and bond markets. They further explore the sources for this performance edge and trace it back
to corporate bonds’ exposure to positively rewarded variance risk premia and low-risk
factors (to be discussed in Chapter 6 (6.3 and 6.4): Credits are effectively short volatility in equity and bond
option markets, and they benefit from leverage aversion (investors prefer to go long corporate
risk through equities than bonds, given the embedded leverage in the former). In contrast, the
authors find that illiquidity cannot explain credits’ performance edge.
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Re: Why Own Corporate Bonds?

Post by vineviz »

Beliavsky wrote: Sun Aug 07, 2022 1:02 pm I excluded some funds since they opened later than 1987. Adding short-term and intermediate-term Treasury bonds and VTSMX (to include small cap stocks), VWEHX still gets 7% weight -- link over the period Jan 1993 - Jul 2022.
Even so, the mean-variance optimizer alone doesn't tell you how IMPORTANT that 7% allocation to VWEHX would have been.

Here's a comparison of your linked portfolio to one without any corporate bonds over the same time period. Even if we select a period like this one, where corporate bonds offered reasonable performance, the difference is immaterial to the point of being almost imperceptible.

Image

There might be behavioral reasons to include high-yield or investment-grade corporate bonds in a portfolio of stocks and Treasury bonds, but there's no evidence that there are any substantial financial reasons to do so.
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Re: Why Own Corporate Bonds?

Post by JBTX »

vineviz wrote: Sun Aug 07, 2022 1:55 pm
Beliavsky wrote: Sun Aug 07, 2022 1:02 pm I excluded some funds since they opened later than 1987. Adding short-term and intermediate-term Treasury bonds and VTSMX (to include small cap stocks), VWEHX still gets 7% weight -- link over the period Jan 1993 - Jul 2022.
Even so, the mean-variance optimizer alone doesn't tell you how IMPORTANT that 7% allocation to VWEHX would have been.

Here's a comparison of your linked portfolio to one without any corporate bonds over the same time period. Even if we select a period like this one, where corporate bonds offered reasonable performance, the difference is immaterial to the point of being almost imperceptible.

Image

There might be behavioral reasons to include high-yield or investment-grade corporate bonds in a portfolio of stocks and Treasury bonds, but there's no evidence that there are any substantial financial reasons to do so.
Seems like the theoretical argument for corporate bonds would be similar to international bonds - that there is theoretical risk in having all of your bonds in one source. You could envision a scenario where US govt bonds become less desirable - although as reserve currency it doesn’t seem likely. There could be scenarios where the strongest US based global corporations are more desired than Treasuries. I don’t expect that, but it isn’t impossible.
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Re: Why Own Corporate Bonds?

Post by dbr »

JBTX wrote: Sun Aug 07, 2022 11:44 pm

Seems like the theoretical argument for corporate bonds would be similar to international bonds - that there is theoretical risk in having all of your bonds in one source. You could envision a scenario where US govt bonds become less desirable - although as reserve currency it doesn’t seem likely. There could be scenarios where the strongest US based global corporations are more desired than Treasuries. I don’t expect that, but it isn’t impossible.
It is difficult to contemplate what the risks in US corporate bonds would be like if US Treasuries become significantly risky. Even the possibility that US Treasuries and stocks would become significantly more risky while world stocks and bonds do not is hard to contemplate.

History in the long term would tell us that anything can happen to anybody, but a realistic estimate of extreme events within some reasonable time-frame is just not possible to have and therefore not possible to implement into a plan.

Back to the thread, how reasonable is it to avoid concentrating in US Treasuries because it must be theoretically true that something could go wrong and, at the same time, those things would not go wrong with the alternatives. Note it is already mooted that one has diversity between US Treasuries and US equities, and maybe even with world equities.
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Re: Why Own Corporate Bonds?

Post by Nowizard »

With a focus on owning both Vanguard Total Bond Index and allocating a portion of bond holdings to a short-term bond fund, we invest in Vanguard Short Term Corporate Index (VFSUX). Not a suggestion discussed here frequently, but one that fits our conceptualization of an appropriate investment for our circumstances. Though IBonds and other individual bond investments are often more recommended, the amount of IBonds purchasable, and the additional time and energy involved in purchase of individual bonds complicate a portfolio for us since we value time more than maximization of potential return.

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Re: Why Own Corporate Bonds?

Post by One More Thing »

muffins14 wrote: Sat Aug 06, 2022 9:40 am Higher yield than treasuries, so if you want yield, they seem like a good choice. price movement may be somewhat irrelevant if you are happy with the income
Corporates have more tax drag OTOH. At least, depending on the state you live in.
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Re: Why Own Corporate Bonds?

Post by One More Thing »

What if you invest in long term corporate bonds when you are young and then gradually shorten your time horizon and tilt towards Treasury bonds as you age? Maximize your ability to accumulate while retaining a bond allocation and then gradually tilt away from those risks as you age and retire? Would that be a waste of time? Would it make more sense to just allocate your Treasuries one way or another from the start?
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Re: Why Own Corporate Bonds?

Post by dbr »

One More Thing wrote: Tue Aug 09, 2022 11:48 am What if you invest in long term corporate bonds when you are young and then gradually shorten your time horizon and tilt towards Treasury bonds as you age? Maximize your ability to accumulate while retaining a bond allocation and then gradually tilt away from those risks as you age and retire? Would that be a waste of time? Would it make more sense to just allocate your Treasuries one way or another from the start?
I think it makes more sense to allocate more to stocks and then less to stocks with age.

While a literal age-in-bonds rules is simplistic and maybe even silly, it might be a general truth that older people will rationally decide to allocate more to bonds with age for a combination of reasons. As always the whole situation needs to be considered.

A basic idea in all this is that setting an asset allocation is both the properties one chooses for stocks or for bonds and that is combined with what you choose for the stock/bond allocation.

A school of thought that might make more sense to some than to others is that one would only hold TIPS as it seems logical to not accept inflation risk in fixed income.

In the end all kinds of combinations get one to the same place. This is not an endeavor where one can engineer precise outcomes.
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Re: Why Own Corporate Bonds?

Post by Bama12 »

Are the bonds in Wellesley income and Wellington Corporate?
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Re: Why Own Corporate Bonds?

Post by vineviz »

Bama12 wrote: Tue Aug 09, 2022 1:06 pm Are the bonds in Wellesley income and Wellington Corporate?
I think they are 20-25% Treasury/agency currently.
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Re: Why Own Corporate Bonds?

Post by muffins14 »

One More Thing wrote: Tue Aug 09, 2022 11:48 am What if you invest in long term corporate bonds when you are young and then gradually shorten your time horizon and tilt towards Treasury bonds as you age? Maximize your ability to accumulate while retaining a bond allocation and then gradually tilt away from those risks as you age and retire? Would that be a waste of time? Would it make more sense to just allocate your Treasuries one way or another from the start?
This would also imply less income as you get older, this less income during the time when you need income from your portfolio. I think it’s just all about how one cares about income stability vs their perception of portfolio present value stability
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Re: Why Own Corporate Bonds?

Post by slicendice »

From the standpoint of a bond portfolio using a 2 or 3 ETFs that is used as an income portfolio that will be depleted over say 30 years: how much risk to real regular annual income stability (I guess quantified using year to year variance) is there, if one compares for example different 50:50 portfolios, one being TIPS:nominal treasuries to one with TIPS:investment grade nominal corporate bonds? Assume the portfolios are duration matching to minimize interest rate risk.

I assume in this scenario one of the biggest contributors to real income variability is inflation. If so what about a strategy using 75% TIPS: 25% high yield corporate bonds (yes, this portfolio will be impossible to tightly duration match).

Even in this type of portfolio-- is the extra-yield just not worth the extra-risks of corporate bonds or is the answer here kind of foggy as in it depends...

It seems to me that the price of rock solid real income stability that one would get from a 30 year TIPS ladder is quite high and if one is willing to tolerate "some?" year to year variation in real income, the corporate bond-containing portfolios would provide that at a much better price.
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Re: Why Own Corporate Bonds?

Post by dbr »

Yes, and the price of a TIPS ladder is quite variable depending on the real yield available when one buys the ladder. Of course one knows what that is at the start, but there may not be much the investor can do about it.
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Re: Why Own Corporate Bonds?

Post by hudson »

zero_coupon wrote: Sat Aug 06, 2022 12:41 am If corporate bonds perform similar to treasurys mixed with a bit of equities, why own corporates?
I can't warm up to corporates. I vote that they are more risky than munis, CDs, and treasuries.
I'd rather go with MYGAs than corporates.
With the possible exception of iShares Inflation Hedged Corporate Bond ETF or LQDI, I'll stick with the highest quality choices.
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Re: Why Own Corporate Bonds?

Post by zero_coupon »

nisiprius wrote: Sat Aug 06, 2022 6:24 am As to "why," I don't know but I'll take some wild guesses. 1) Tradition? 2) Unavailability of intermediate-term Treasury bonds in convenient mutual fund form until around the late 1990s? 3) An preference for products based on business earnings over government products? 4) A feeling that having 100% of bonds from a single issuer, even when the issuer is the U.S. Treasury, isn't diversified ennough?
Useful analysis. Thank you. I was thinking along these lines.
McQ wrote: Sat Aug 06, 2022 4:13 pm I wrote a paper describing those problems (which fade away after 1973) here: https://papers.ssrn.com/sol3/papers.cfm ... id=3740190, "When Do Corporate Bond Investors Earn a Premium for Bearing Risk? A Test Spanning the Great Depression of the 1930s."
Excellent. Thank you for this contribution.
KlangFool wrote: Sat Aug 06, 2022 5:03 pm OP, I owned corporate bonds through my actively managed Wellington Fund. I do not think non finance professional should buy corporate bonds.
You mean individual corporates? How about individual munis?
djm2001 wrote: Sun Aug 07, 2022 7:27 am The following excerpt from Prof. Sharpe's RISMAT book helped me understand an important difference between corporate bonds and treasury bonds:
Thank you for this.
invest2bfree wrote: Sun Aug 07, 2022 9:31 am If you buy it from large cap valued companies and be diversified then they are reasonable safe. Also Fidelity makes it a breeze to buy.
Individual corporates, not a fund? How do you select? Research?
Beliavsky wrote: Sun Aug 07, 2022 1:02 pm In the book Investing Amid Low Expected Returns (2022), Ilmanen cites a 2016 paper by Asvanunt and Richardson and the book Ben Dor, Arik: Albert Desclee: Lev Dynkin: Jay Hyman; Simon Polbennikov (2021), Systematic Investing in Credit to support investing in corporate bonds:
Interesting. Thanks.
Nowizard wrote: Mon Aug 08, 2022 8:05 am With a focus on owning both Vanguard Total Bond Index and allocating a portion of bond holdings to a short-term bond fund, we invest in Vanguard Short Term Corporate Index (VFSUX).
Short corporates seem to perform similar to Total Bond, but with a smoother ride. Worth considering.
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Re: Why Own Corporate Bonds?

Post by KlangFool »

zero_coupon wrote: Wed Aug 10, 2022 11:59 pm
KlangFool wrote: Sat Aug 06, 2022 5:03 pm OP, I owned corporate bonds through my actively managed Wellington Fund. I do not think non finance professional should buy corporate bonds.
You mean individual corporates? How about individual munis?
zero_coupon,

I know that I am not smart enough to choose and buy individual bond. Hence, I hire the Welling Fund management to do it. There is no reason for me to do active management either. Wellington Fund expense ratio is 0.16%. I cannot beat that in cost too.

So, why would someone spend more time, effort, and money to try to beat the professionals?

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Re: Why Own Corporate Bonds?

Post by zero_coupon »

KlangFool wrote: Thu Aug 11, 2022 7:26 am
zero_coupon wrote: Wed Aug 10, 2022 11:59 pm
KlangFool wrote: Sat Aug 06, 2022 5:03 pm OP, I owned corporate bonds through my actively managed Wellington Fund. I do not think non finance professional should buy corporate bonds.
You mean individual corporates? How about individual munis?
zero_coupon,

I know that I am not smart enough to choose and buy individual bond. Hence, I hire the Welling Fund management to do it. There is no reason for me to do active management either. Wellington Fund expense ratio is 0.16%. I cannot beat that in cost too.

So, why would someone spend more time, effort, and money to try to beat the professionals?

KlangFool
Reasonable strategy.
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Re: Why Own Corporate Bonds?

Post by 3funder »

Corporate bonds are not always quite as sensitive to higher interest rates and can add to returns.
Global stocks, US bonds, and time.
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enad
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Re: Why Own Corporate Bonds?

Post by enad »

Parkinglotracer wrote: Sat Aug 06, 2022 5:21 am A cfa that headed up an independent RIA firm taught me to stick to us gov bonds and take corporate risk on the equity side of my investments. Not the end of the world but Total bond fund has corporate bonds and a longer duration than i prefer so I stick mainly 1-3 year treasury securities easily avail on vanguard brokerage.
Total Bond Market (BND) is roughly 2/3 IT HQ Gov bonds & 1/3 IT HQ Corp Bonds. If you wanted to do the same on the ST side, use 2/3 VGSH (ST HQ Gov bonds) and 1/3 VCSH (ST HQ Corp Bonds).

I use 6 bond funds as follows:
30% Short Term (50/50 Split VGSH / VCSH)
20% TIPS (50/50 Split VTIP / SPIP)
50% Inter Term (50/50 Split VGIT / VCIT)

Portfolio Visualizer showed what this would look like from Nov 2012 to July 2022 for the 6 bonds vs 3 bonds (all Gov):

Portfolio Initial Final CAGR Stdev Best Worst MxDD Sharpe Sort Mkt Cor
Portfolio 1 $10,000 $11,234 1.20% 2.33% 5.81% -3.65% -5.95% 0.26 0.38 -0.09
Portfolio 2 $10,000 $11,815 1.73% 3.13% 8.17% -5.55% -8.68% 0.36 0.53 0.30

It boosts the bond return with little risk. I have been doing this for nearly 20 years
What Goes Up Must come down -- David Clayton-Thomas (1968), BST
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Re: Why Own Corporate Bonds?

Post by enad »

Parkinglotracer wrote: Sat Aug 06, 2022 5:21 am A cfa that headed up an independent RIA firm taught me to stick to us gov bonds and take corporate risk on the equity side of my investments. Not the end of the world but Total bond fund has corporate bonds and a longer duration than i prefer so I stick mainly 1-3 year treasury securities easily avail on vanguard brokerage.
The flip side is this. Many corporate bonds are issued by very large cap companies. Would Apple, Microsoft or Amazon risk a bond default and not worry what it would do to its share price? Many of the corporate bond funds have AAA, AA, A and BBB holdings. Very few have anything less which is considered speculative or junk.
What Goes Up Must come down -- David Clayton-Thomas (1968), BST
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Re: Why Own Corporate Bonds?

Post by dml130 »

Wouldn't short term corporates (like VCSH) be among the best performers in a stagflationary environment?
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Re: Why Own Corporate Bonds?

Post by invest2bfree »

One More Thing wrote: Tue Aug 09, 2022 11:48 am What if you invest in long term corporate bonds when you are young and then gradually shorten your time horizon and tilt towards Treasury bonds as you age? Maximize your ability to accumulate while retaining a bond allocation and then gradually tilt away from those risks as you age and retire? Would that be a waste of time? Would it make more sense to just allocate your Treasuries one way or another from the start?
This is exactly what I do.

Iam 48, I have 22 years corporate bonds which will start expiring when Iam 70.
I plan to take SS at 70.

Once I get SS I might not need the extra yield.
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Re: Why Own Corporate Bonds?

Post by JSPECO9 »

I own 90% S&P 500, and 10% short-term corporates.
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Re: Why Own Corporate Bonds?

Post by comeinvest »

petulant wrote: Sat Aug 06, 2022 8:54 am
vineviz wrote: Sat Aug 06, 2022 8:40 am
dbr wrote: Sat Aug 06, 2022 8:18 am In general corporate bonds have more risk and should offer more return. If one is only investing in bonds then a person who wants to take more risk for more return would add corporates. Mr. Bogle was heard to take issue with the total bond fund portfolio asking for more corporates for more return.
I have found that corporate bonds are increasingly important in portfolios that are more more than 50% bonds, similar to the greater importance of TIPS in such equity-light portfolios.
Among the things that are not stable about the relationships here, the proportion of treasury + stock to corporate bonds is not stable for different asset allocations of the portfolio. Above, nisiprius found that a 60/40 allocation using corporate bonds had the same standard deviation as 65.5% stocks/34.5% treasury bonds, implying a roughly 11% stock and 89% treasury split for corporate bonds. But if we adjust the initial portfolio to a 30/70 allocation using corporate bonds, the equalized standard deviation requires a whopping 40.8% stock and 59.2% treasury allocation--though again, with better return, better Sharpe ratio, and lower max drawdown for the stock+treasury portfolio. Since we replaced 10.8% of the portfolio out of a 70% bond allocation with stocks, that roughly implies a ratio of 15% stock and 85% treasury split for corporate bonds--more stock-like than nisiprius's original model. Most likely, if we ran this exercise again for various time periods and bond durations, we would probably get even more different results. I would liken it to the efficient frontier or even the relationship between bond duration and interest rate movements--we can get a number that's interesting, but it's very time dependent (efficient frontier) or expresses a relationship at a tangency that can move in unintuitive ways the further from the tangency we get (bond duration). If so, it makes sense that with a more bond-heavy portfolio and with fine-tuning around duration, using corporates may be a more valuable option.

Link to adjusted simulation
Wouldn't it be a more precise breakdown of corporate bonds sources of risk/return to break them down into duration risk and credit risk? The duration risk of the corp bonds can be precisely mapped to the duration of treasuries (that's the easy part); the credit risk/return would be an overlay with a certain stock market beta on top of the duration risk/return? Nobody says that the breakdown needs to add up to 100%.

Unless there is a meaningful correlation of credit spreads with interest rate environments, in which case we would need more accurate models.
Last edited by comeinvest on Sat Mar 11, 2023 5:51 am, edited 1 time in total.
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Re: Why Own Corporate Bonds?

Post by comeinvest »

McQ wrote: Sat Aug 06, 2022 4:13 pm This paper by practitioners found no improvement from adding corporate bonds to a stock / government bond portfolio: https://papers.ssrn.com/sol3/papers.cfm ... id=3147005.

However, they were constrained by the deeply flawed index of long corporate bond returns included in the Ibbotson SBBI. I wrote a paper describing those problems (which fade away after 1973) here: https://papers.ssrn.com/sol3/papers.cfm ... id=3740190, "When Do Corporate Bond Investors Earn a Premium for Bearing Risk? A Test Spanning the Great Depression of the 1930s."

I collected a new series of long corporate bonds to replace the SBBI series.

The charts below will capture the gist of the findings. (Blue line equals corporate returns).

1. At the high end of the investment-grade spectrum, the long run realized premium on corporate bonds runs 15 - 20 basis points.
2. Because the premium is so small, it can be wiped out in crises (i.e., after a multi decade holding period, having to sell at the wrong moment leaves you with no improvement over Treasuries)

Image


After 100 years, briefly in 2009 the long run return on corporates was no better than Treasuries.

3. On the other hand, although corporate bonds take a deeper hit during crises, they bounce back much faster than Treasuries.

Image

Quoting from the notes to this figure:
Data for the 1929 crisis is new data collected for this paper drawn from Table 1. Data for the 2008 crisis is the long corporate and government bond returns published in the SBBI. Charts show that while the drawdown on corporate bonds is much deeper at the point of crisis, the bounce back is likewise much steeper, so that within a few years of the crisis bottom, the corporate bond investor pulls ahead, consistent with the existence of a long-term premium, however small, on corporate bonds ...

A factor not always appreciated in conventional financial planning, with its recommendation to flee to government bonds when a crisis looms, is that government bonds themselves do not do all that well at the onset of crises. Certainly they decline less than stocks; but Treasuries took a hit after the devaluation of the British pound in Fall 1931 sent the Depression into overdrive. And Treasuries had a YTD negative return as late as the month after the Lehman bankruptcy in 2008. When Treasuries did soar at the end of 2008, corporate bonds rallied even more steeply. Then as the stock market turned the corner in Spring 2009, Treasuries lagged and corporate bonds got a second wind. Yes, yield spreads do blow out in times of crisis; but that sharp, brief spike does not entail that returns plummet when measured over the months (years) following. The corporate premium gets earned in crises too.

A final point: there is always a yield premium on corporate bonds, and it's generally more than 15-20 bp. But only a part gets harvested as returns. The problem is not defaults, but other factors that undermine the promised yield (arithmetic examples in an appendix).
Thanks for your data; but what is your conclusion in regards to the first sentence of your post "This paper by practitioners found no improvement from adding corporate bonds to a stock / government bond portfolio"? Does your study validate or refute that thesis? I can't see any risk-adjusted analysis or (more importantly) any risk-adjusted analysis within a stocks/bonds portfolio in your post, sorry if I missed it.
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Re: Why Own Corporate Bonds?

Post by Beliavsky »

zero_coupon wrote: Sat Aug 06, 2022 12:41 am If corporate bonds perform similar to treasurys mixed with a bit of equities, why own corporates?
Someone has to own them, and as interest-paying securities they are easy to understand at a high level. They are less liquid than Treasuries and are subject to state income tax. That ought to raise their yield and make them attractive to long-term holders in tax-deferred accounts. Even if your baseline allocation to corporate bonds is zero, I think you ought to consider them when yield spreads get large enough, as they did by the end of 2008. Has anyone looked at a strategy that switches between corporates and Treasuries based on some measure of yield spreads?

Bogleheads believe markets are pretty efficient and that you should own everything. Given those priors, I think the onus is on corporate bond avoiders to prove that doing so is optimal, rather than corporate bond investors to prove that they should be owned. The data is inconclusive, so neither case can be proved.

There are other fixed income assets such as mortgages, preferred stocks, convertibles, bank loans, and asset-backed securities that I think should also be considered (by a portfolio manager you trust).
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Re: Why Own Corporate Bonds?

Post by vineviz »

Beliavsky wrote: Sun Sep 11, 2022 6:42 am Bogleheads believe markets are pretty efficient and that you should own everything.
Not all Bogleheads believe this.

Even ones who think that "markets are pretty efficient" should understand that this efficiency does NOT imply that " you should own everything".

The market may be efficient in aggregate, but the market contains a variety of investors with different preferences, different amounts of wealth, different investment horizons, different investment constraints, different tax rates, etc.

Investors should take those differences into account when choosing their asset allocation.
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Re: Why Own Corporate Bonds?

Post by seajay »

I, or rather the stocks I invest in, typically own (sell) corporate bonds to raise capital (borrow), as such owning corporate bonds (albeit indirectly) if you invest in a broad range of stocks is pretty much unavoidable.
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Re: Why Own Corporate Bonds?

Post by petulant »

comeinvest wrote: Sun Sep 11, 2022 5:07 am
petulant wrote: Sat Aug 06, 2022 8:54 am
vineviz wrote: Sat Aug 06, 2022 8:40 am
dbr wrote: Sat Aug 06, 2022 8:18 am In general corporate bonds have more risk and should offer more return. If one is only investing in bonds then a person who wants to take more risk for more return would add corporates. Mr. Bogle was heard to take issue with the total bond fund portfolio asking for more corporates for more return.
I have found that corporate bonds are increasingly important in portfolios that are more more than 50% bonds, similar to the greater importance of TIPS in such equity-light portfolios.
Among the things that are not stable about the relationships here, the proportion of treasury + stock to corporate bonds is not stable for different asset allocations of the portfolio. Above, nisiprius found that a 60/40 allocation using corporate bonds had the same standard deviation as 65.5% stocks/34.5% treasury bonds, implying a roughly 11% stock and 89% treasury split for corporate bonds. But if we adjust the initial portfolio to a 30/70 allocation using corporate bonds, the equalized standard deviation requires a whopping 40.8% stock and 59.2% treasury allocation--though again, with better return, better Sharpe ratio, and lower max drawdown for the stock+treasury portfolio. Since we replaced 10.8% of the portfolio out of a 70% bond allocation with stocks, that roughly implies a ratio of 15% stock and 85% treasury split for corporate bonds--more stock-like than nisiprius's original model. Most likely, if we ran this exercise again for various time periods and bond durations, we would probably get even more different results. I would liken it to the efficient frontier or even the relationship between bond duration and interest rate movements--we can get a number that's interesting, but it's very time dependent (efficient frontier) or expresses a relationship at a tangency that can move in unintuitive ways the further from the tangency we get (bond duration). If so, it makes sense that with a more bond-heavy portfolio and with fine-tuning around duration, using corporates may be a more valuable option.

Link to adjusted simulation
Wouldn't it be a more precise breakdown of corporate bonds sources of risk/return to break them down into duration risk and credit risk? The duration risk of the corp bonds can be precisely mapped to the duration of treasuries (that's the easy part); the credit risk/return would be an overlay with a certain stock market beta on top of the duration risk/return? Nobody says that the breakdown needs to add up to 100%.

Unless there is a meaningful correlation of credit spreads with interest rate environments, in which course we would need more accurate models.
To the first point, yes--perhaps we would say that corporate bonds are a risk-free real rate plus a term premium (duration) and credit premium. The duration risk can't be precisely mapped to treasuries, though, because the premia of corporate bonds are generally expressed through a higher coupon, which reduces the duration of an issue with the same maturity. So there are going to be weird, imprecise things going on between credit spreads and duration. Further, while it makes sense to liken the credit premium to a limited beta exposure, it might be that stock returns also have some correlation or interaction with the risk-free real rate or term/duration. So what I'm saying is that there's no precise model to be had, just approximations.
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Re: Why Own Corporate Bonds?

Post by Beliavsky »

seajay wrote: Sun Sep 11, 2022 7:50 am I, or rather the stocks I invest in, typically own (sell) corporate bonds to raise capital (borrow), as such owning corporate bonds (albeit indirectly) if you invest in a broad range of stocks is pretty much unavoidable.
Since corporations are net debtors, by owning a stock index fund you are effectively short, not long, corporate bonds. That could argue for being long corporate bonds in other funds.
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Re: Why Own Corporate Bonds?

Post by seajay »

Beliavsky wrote: Sun Sep 11, 2022 7:57 am
seajay wrote: Sun Sep 11, 2022 7:50 am I, or rather the stocks I invest in, typically own (sell) corporate bonds to raise capital (borrow), as such owning corporate bonds (albeit indirectly) if you invest in a broad range of stocks is pretty much unavoidable.
Since corporations are net debtors, by owning a stock index fund you are effectively short, not long, corporate bonds. That could argue for being long corporate bonds in other funds.
Yes, I did emphasise that by including the braces "(sell)".

A twist on "Ownership" semantics. The stocks/firms that issue Corporate Bonds might be considered as owning those bonds, that are then sold in the open market such that buyers lend in return for interest payments and a return of capital when the bond matures and ownership is returned to the issuer (owner) :)

Consider a 'typical' case of a $100M book-value firm that borrows $50M via selling corporate bonds, that with that combined $150M of capital generates a 12%/year profit from business activities. $18M profits, less perhaps 6% interest payments on the $50M of debt ($3M) to leave $15M net profits (15% return relative to book-value). Investors might be content with around a 7,5% return so bid up the share price to around twice book-value. Around 25c of every $1 deployed to buy shares in effect has around 25% of short bond exposure factor integral to that purchase. To negate the debt (short corporate bonds) you could asset allocate 80/20 stock/corporate bond, but that's a unproductive use of capital, little/no different to a 20% allocation of borrowing/lending to oneself - for 0% nominal overall return (worse after you factor in inflation).

Broadly corporate bond interest rates whilst being higher than treasury bond interest rates - that just reflects the default risk. For longer term investors including bonds/treasuries as part of asset allocation doesn't reduce risk (or rather only does so in a very small proportion of cases). 30 year 3.33% SWR (return of inflation adjusted money via 30 yearly instalments) and measure the outcome for all start years over the last 150 years and you ended up with comparable worst case outcomes, worse average case outcome when bonds where included compared to not holding any bonds (all-stock). Excepting very rare cases (1929/1930, 1973 start years) - that averaging in rather than lumping in resolves.

Image

So if 30 year SWR is your objective/risk then bonds did not reduce that risk other than in a very small number of cases (1973 was minimal difference). Bonds are more appropriate for shorter term investing, where stock risk is more variable. Some say you should have a chunk of bonds for unexpected expenses, however identifying a appropriate amount for that is very speculative, better if you hold all-stock and if say a $50K sudden expenses arises at a time when stocks are down then borrow that $50K instead, with a intent to pay that back when stocks have recovered. $1M portfolio that was formerly $2M - but saw stocks halve, need to pay $50K for a unexpected home roof replacement, rotate into a $900K 1x, $50K 2x leveraged stock allocation (2x leveraged fund in effect borrows $50K at whatever the overnight rate is at the time (formerly LIBOR)). Stock value subsequently rebounds back up to $2M, then sell the $50K in 2x and buy 1x with the proceeds.
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Re: Why Own Corporate Bonds?

Post by petulant »

Beliavsky wrote: Sun Sep 11, 2022 7:57 am
seajay wrote: Sun Sep 11, 2022 7:50 am I, or rather the stocks I invest in, typically own (sell) corporate bonds to raise capital (borrow), as such owning corporate bonds (albeit indirectly) if you invest in a broad range of stocks is pretty much unavoidable.
Since corporations are net debtors, by owning a stock index fund you are effectively short, not long, corporate bonds. That could argue for being long corporate bonds in other funds.
By how much and how are you measuring it? Banks and insurance companies are long a lot of loans and bonds, but their liabilities aren't exactly short corporate bonds. Plus the top 10 of S&P 500 have a lot of treasuries (think Apple, BRK, etc.)
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Re: Why Own Corporate Bonds?

Post by Beliavsky »

petulant wrote: Sun Sep 11, 2022 8:55 am
Beliavsky wrote: Sun Sep 11, 2022 7:57 am
seajay wrote: Sun Sep 11, 2022 7:50 am I, or rather the stocks I invest in, typically own (sell) corporate bonds to raise capital (borrow), as such owning corporate bonds (albeit indirectly) if you invest in a broad range of stocks is pretty much unavoidable.
Since corporations are net debtors, by owning a stock index fund you are effectively short, not long, corporate bonds. That could argue for being long corporate bonds in other funds.
By how much and how are you measuring it? Banks and insurance companies are long a lot of loans and bonds, but their liabilities aren't exactly short corporate bonds. Plus the top 10 of S&P 500 have a lot of treasuries (think Apple, BRK, etc.)
Yardeni wrote in 2019 that the debt/equity ratio of the S&P 500 was 0.86. Since interest in corporate debt is a tax-deductible expense, and since debt is cheaper than equity, on average companies will be debtors.
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Re: Why Own Corporate Bonds?

Post by invest2bfree »

zero_coupon wrote: Sat Aug 06, 2022 12:41 am If corporate bonds perform similar to treasurys mixed with a bit of equities, why own corporates?
Yield is a main reason.

LT treasuries is giving you 3%.

LT corporate Bonds is 6%.

Also if you can buy a basket of individual bonds and closely align with your investment horizon then Sequence of Return Risk is greatly reduced.

1Million 60% VT and 40% Corporate Bonds can give you $13,500+$24,000 = $37,500 in income.

Whereas a 60% VT and 40% BND gives = $25,500 in income.
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Re: Why Own Corporate Bonds?

Post by seajay »

petulant wrote: Sun Sep 11, 2022 8:55 am
Beliavsky wrote: Sun Sep 11, 2022 7:57 am
seajay wrote: Sun Sep 11, 2022 7:50 am I, or rather the stocks I invest in, typically own (sell) corporate bonds to raise capital (borrow), as such owning corporate bonds (albeit indirectly) if you invest in a broad range of stocks is pretty much unavoidable.
Since corporations are net debtors, by owning a stock index fund you are effectively short, not long, corporate bonds. That could argue for being long corporate bonds in other funds.
By how much and how are you measuring it? Banks and insurance companies are long a lot of loans and bonds, but their liabilities aren't exactly short corporate bonds. Plus the top 10 of S&P 500 have a lot of treasuries (think Apple, BRK, etc.)
It's dynamic - best left to the collective firms/market. Same for currencies (some firms hedge their FX, others don't). A world stock tracker includes FX and bond exposure factors, as determined by the collective market, add/short elements/factors if you so desire, but its unlikely that you're guess will be any better than the collectives.

Buffett suggests the US S&P500 is a good enough, within which many of the stocks have global business exposure. He also advocates that if you have $1M along with $30K/year of dividends rolling in, that if the kids have flown the nest, no debt, own your own home and you have modest spending, then NO cash is appropriate

6:10 into ... https://youtu.be/SEZwkbliJr8

If you have pensions income on top of that, so much the better (pensions might be considered as a form of bond-like 'asset').
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