The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

INTERNATIONAL CORPORATE BONDS

The yield spread of a corporate bond relative to a government bond is negatively correlated to the growth of the economy. Greater economic growth in the global economy generally provides greater profitability to corporations by reducing the probability of default. Yield spreads of corporate bonds over government bonds narrow as default risk diminishes. Cursory empirical evidence indicates that the inflection points of the yield spreads are related to turning points of bond yields.

A portfolio manager who can confidently identify the transition from recession to growth and vice versa can add substantially to portfolio performance. Not only will he forecast, accurately, the change in the direction of interest rates and aid in currency selection, but he will also add tremendous value with their sector choices. Empirical evidence suggests that low quality corporate bonds satisfy the confident high growth forecast. Holding global government bond rates constant, the most potent relative returns would result from low quality, noncallable, long maturity corporate bonds in improving emerging market countries. Alternatively, corporate bonds should be sold entirely if an economic slowdown or recession is forecast or “buy protection” using credit default swaps to hedge or to profit from widening credit spreads.

Corporate bond spreads reflect the quality of the credit (issuer’s credit rating) and the credit quality of the country of domicile. For this reason, ...