Source: RBA
Despite the above chart being a few weeks old, the above chart shows credit spreads have widened significantly over the past few months such that at the end of November, both A and BBB rated corporates have spreads in excess of 300bps. When you consider that the historic default risk is much much lower than these spreads I do believe accepting this type of risk in a well diversified portfolio (that is, with a fund) is an investment that could provide good returns over the next few years. The biggest issues with this type of portfolio relates to liquidity and the ongoing volatility.
Liquidity, or the potential lack of, is why the spreads are as wide as they are. So holding credit investment for as long as possible or through to maturity is recommended. Volatility risk is expected to be quite high as the correlation will be strong with equities. So whilst there is potential for short term falls in value for corporate credit, as long as defaults don’t hit very high and significant record levels, this type of investment should provide a decent return over the next few years. So now that I’ve written it, I guess finding a relatively passive credit fund is the next challenge.
The last thing I want to say regarding corporate credit spreads that are reflected in the above chart is the fact that there is probably a high proportion of banking and other financial services debt included in there. Because it is Australian and our financial institutions appear to be much much stronger than our international counterparts, at this stage I’m not particularly concerned…but it is the financial institutions that will create the volatility in this index thanks to the European situation and the difficulty in raising overseas capital.