The implied risk of investing in junk bonds dropped below that of holding investment-grade and Treasury securities last month for the first time in three years, according to Mike Thompson, market strategist at RiskMetrics Group. And, while the anomaly has since reversed itself, with junk bonds carrying more volatility and risk than higher-rated paper, he says the development indicates Wall Street dealers feel they are being adequately paid for taking risk in junk bonds. Furthermore, he says it indicates the junk bond rally may not be over, as the data supports near-term price stability. "The bond rally isn't going to come to a bloody reverse turn right now."
RiskMetrics calculated an average 1.40% variance-at-risk, or VAR, for 10-year double-B rated bonds in mid-August, compared to 1.48% for triple-A bonds. VAR measures how much a trader would stand to lose in one day based on a basket of underlying securities and their volatility. RiskMetrics does its calculation using buckets of 10-year bonds in different ratings classes as ascribed by Moody's Investors Service. "It's not normal for Treasuries and investment-grade paper to have a larger VAR than junk bonds. It's really an indication of the anxiety of the traders that have taken the credit risk, and their expectations for the future," Thompson explains.