CreditSights: The Week In Credit
For multi-sector funds looking to get the best bang for their buck, an evaluation of historical risk-adjusted returns across a range of asset classes is key. We look at Sharpe ratios for fixed-income over the past one, two, five and 10 years. Over a long-term horizon, the high-grade credit tiers appear to win hands down, with mortgages, agencies and corporates in the top three spots over a 10-year period and within the top four rankings (emerging markets was second) over five years. Predictably, high-grade assets and U.S. Treasuries are also the least volatile. Equities end up looking the least attractive as the severe downturn after March 2000 offset the record-breaking returns achieved in the mid-late 1990s and volatility was consistently the highest among all of the asset classes.
As we continue to see an improvement in risk appetite on the part of investors, the high-beta asset classes will outperform at least on a short-term basis. Over the past year, investors with the most risk tolerance have been generously rewarded. High-yield continues to post equity-like swings in excess returns, implying that strategic allocation to specific names still drives performance; emerging markets is largely a country-selection call, particularly over periods when countries dominating the index are hit by a financial crisis. The recovery in tech stocks drove up the NASDAQ to an annualized excess return of 39%, but high volatility diluted the upside and the index ended up below emerging market and high-yield on a risk-adjusted basis.
For investors with less risk tolerance, the corporate market has offered ample opportunities since last October. U.S. corporates came in with double-digit (11.6%) annualized excess returns and European corporates posted an impressive 8%. Given where these markets are currently trading, we are heading for more-subdued performance metrics over the next 12 months. U.S. corporates have underperformed mortgages historically (based on two, five and 10-year risk adjusted ratios), but outperformed mortgages by 80 basis points this past year. Similarly, corporates have tended to perform closely in line with agencies in the past, but outperformed agencies by 106 basis points over the previous 12 months.