Credit
In the corporate bond universe, for example, the historical
default rate for all Global corporate bond issuers considered
“Investment Grade” has not been higher than 0.41% per
year in the last 30 years, with that figure achieved in 2008.
The default rate for AAA securities is zero. Naturally, if
AAA rated securities offered the same yield as the rest of
the investment grade global corporate bond universe, one
would choose the AAA rated one. The yields are not the
same, however, they are vastly different, benefitting the
non-AAA investor with better returns in nearly all periods of
the last 30 years regardless of the interest rate environment
and nearly always by more than 0.41%, the highest default
rate. In fact, corporate bonds tend to outperform AAA
investments and US Treasuries in periods of both mildly
rising and rapidly rising interest rates. Why? Income. You
simply get compensated correctly with better income, at
most times (2008 excepted), for taking what has turned out
to historically be a very low level of credit risk, as judged by
the actual default record.
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The fixed income investment universe is vast, with
investment choices much more numerous than the equities
markets. Within this universe, captives have tended to limit
themselves to an investable universe that eliminates most
of the potential income generation available to the average
fixed income investor. The limitation that imposed is on
“credit risk”, the risk that any given fixed income investment
will experience a default. In our experience, many captives
have historically limited themselves to the two highest rating
categories, with some only allowing AAA rated assets in their
portfolios. This is beginning to change, as short rates have
been zero for so long and providers of letters of credit become
more sophisticated, but it is changing very slowly. Some of
this is natural con ͕