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Key Takeaways:

  • Since 1997, investment-grade corporate bonds have outperformed U.S. Treasury bonds by an average of 1.62%.
  • Historically, when option-adjusted spreads on investment-grade corporate bonds exceeded 1%, investors’ portfolios benefited in the following three years.

Corporate-bond spreads can give investors important insights into the temperament of financial markets. Wide spreads reflect investor fear and trepidation while tight spreads demonstrate confidence in the future. Armed with a better understanding of corporate-bond spreads, investors navigating volatile markets may be able to capitalize on corporate-bond-buying opportunities.

What is a Credit Spread?

A credit spread is the difference in yield between two bonds of the same maturity but with different credit quality. Treasury bonds are the purest form of interest rates. Since they are backed by the U.S. government, Treasuries carry very low risk. With almost no chance of default, their spread is zero. Investment-grade corporate bonds have a greater yield than Treasuries because of a slight chance of default. This excess yield between Treasuries and investment-grade corporate bonds is the spread. High-yield bonds and their higher rate of default create an even greater spread.

Do corporate-credit spreads over Treasuries vary?

Corporate spreads are dynamic. Since 1997, investment-grade corporate spreads have been as high as 6.56% during the Great Recession of 2008, and as low as 0.53% in 1997 when volatility across asset classes hit a trough. Since 1997, investment-grade, corporate-credit spreads averaged 1.55%.

Investment-Grade Corporate-Credit Spreads

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Performance data quoted represents past performance, which does not guarantee future results. Current performance may be lower or higher than the performance quoted. The investment return and principal value of an investment will fluctuate so that shares, when redeemed, may be worth more or less than the original cost.

Have investment-grade, corporate-bond spreads Growth of $10,000 provided enough compensation to investors for the increased risk over Treasury bonds?

Put simply, yes. Since 1997, 1-3 year investment-grade corporate bonds produced 1.36% in excess returns over rolling 3-year periods compared to 1-3 year Treasuries. Over the same period, 5-7 year corporates generated 1.25% in excess returns compared to 5-7 year Treasuries over rolling 3-year periods.

If investment-grade corporate-bond defaults were greater than the investment-grade spread over Treasuries, then Treasury bonds would have outperformed them. But historically, Treasuries haven’t outperformed because investment-grade bond defaults tend to run very low. In fact, in some years, no defaults have occurred. This makes investment-grade bonds attractive to many investors when compared against Treasury bonds.

Historically, corporate bonds have outperformed Treasuries of the same maturity.

Average Rolling 3-Year Performance Since 1997

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Growth of $10,000

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Over time, corporate bonds have historically outperformed similar maturity Treasuries.

1-3 Year Corporates Outperformed 1-3 Year Treasuries 91% of 3 Year Periods Since 1997

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5-7 Year Corporates Outperformed 5-7 Year Treasuries 74% of 3 Year Periods Since 1997

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Average outperformance over Treasuries when spreads reach certain levels.

Historically, corporate bonds have outperformed Treasuries of the same maturity when spread levels eclipse 1%.

Historical 3-year Outperformance/Underperformance of Investment-Grade Corporate Bonds Versus Treasuries at Various Spread Levels

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When spread levels were greater than 1%, 1-3 year corporate bonds outperformed Treasury bonds of the same maturity 98% of the time. When spreads were greater than 1.5%, that number jumped to 100%.

1-3-Year Corporate Bonds Outperformed 1-3-Year Treasuries 99% of the Time When Spreads Were Greater Than 1%

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Similarly, 5-7 year corporate bonds have shown greater levels of outperformance when spreads eclipse 1%. When spreads were greater than 1.5%, 5-7 year corporates have never underperformed their Treasury counterparts since 1999.

5-7 Year Corporate Bonds Outperformed 5-7 Year Treasuries 92% of the Time When Spreads Were Greater Than 1%

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Bottom Line

When investors are nervous and spreads widen, investors’ asset-allocation mixes have historically benefited by utilizing corporate credit.

Definitions

The Bloomberg Barclays 1-3 Year U.S. Treasury Index measures U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury with years to maturity equal to or greater than 1 and less than 3.

The Bloomberg Barclays U.S. Treasury 5-7 Year Index measures U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury with years to maturity equal to or greater than 5 and less than 7.

The ICE BofA Merrill Lynch 1-3 Year U.S. Corporate Index is a subset of the ICE BofAML U.S. Corporate Master Index that includes all securities with a remaining term to maturity of less than 3 years.

The ICE BofA Merrill Lynch 5-7 Year U.S. Corporate Index is a subset of the ICE BofAML U.S. Corporate Master Index that includes all securities with a remaining term to maturity greater than or equal to 5 years and less than 7 years.

The ICE BofA Merrill Lynch U.S. Corporate Master Index tracks the performance of U.S. dollar denominated investment grade rated corporate debt publicly issued in the U.S. domestic market.

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All investing involves risks including the possible loss of the principal amount invested. Corporate bonds are subject to issuer risk in that their value may decline for reasons directly related to the issuer of the security. Not all U.S. government securities are checked or guaranteed by the U.S. government, and different government securities are subject to varying degrees of credit risk.

Pacific Life Insurance Company is the administrator for Pacific Funds. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products.

You should consider a fund's investment goal, risks, charges, and expenses carefully before investing. The prospectus and/or the applicable summary prospectus contain this and other information about the fund and are available from your financial advisor. The prospectus and/or summary prospectus should be read carefully before investing.

Mssrs. Masemer and Imamura are registered with, and Pacific Funds are distributed by Pacific Select Distributors, LLC (member FINRA & SIPC), a subsidiary of Pacific Life Insurance Company (Newport Beach, CA), and are available through licensed third parties. Pacific Funds refers to Pacific Funds Series Trust.

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