saluki9 said:
I (along with some other more famous people) do not like corporate bonds. IMHO you are taking on all the the risk of stockholders and getting instead a limited and fixed return. In addition, for doing so you get much much less of the diversification benefit that you would from other fixed income sources.
saluki9,
Thanks for working up this data. It is interesting indeed. However, I'm hesitant to change my thinking about asset allocation based on 5 years of correlation data.
To me, correlation data is a reasonable thing to consider in figuring out an asset allocation stratgey. However, I think we (the world!) place way too much stock in the recent correlation data in making allocation decisions. Making investment decisions based on 3-7 years worth of correlation data is a lot like making them based on 3-7 years worth of returns data. In short, recent correlations may not be a good predictor of future correlations.
So while I certainly pay attention to correlation data and the output of optimizers, I pay more attention to the underlying "return generating process" of each asset class (I got this phrase from indexinvestor.com)
The idea is to think about the forces that generate returns for each asset class in your portfolio. Are those forces similar or different between asset classes? Are the risks similar or different? Are there structural reasons to believe the relationships or the underlying return generating processes have changed or will change?
For example, IMHO corporate bonds are fundamentally different animals from government bonds in terms of the risks and the return opportunities that underly the two investments. They have different return generating processes and bacause of that are unlikely to be (or stay) correlated over the long haul.
Also, I would bet a large sum of money (in fact I guess I am) that corporate bond returns will not stay correlated to stocks over the next 30-40 years. For example, after a 25% market crash, if investor psychology fundamtentally shifts away from equities (which it does from time to time), demand for stocks is likely to fall vs demand for bonds, and hence their respective returns will be different.
So while I could accept (or at least consider) a market timing argument that the risk of corporate bonds is mispriced by the market right now, I'd disagree with an argument that corporate bonds and stocks have similar return generating processes and therefore are likely to move in lock-step.
I know this thinking is controversial and many respected people disagree with me, but hey, sometimes it's fun to buck the conventional wisdom...
Jim