Monday, September 29, 2008

Corporate Bonds: When Safe Asset Classes Become Risky

We hear about "credit crisis" and "risk aversion", but I thought I would make those issues much more concrete for readers. This is not some volatile stock or sector, and it's not a bank. This is a chart of LQD, the iShares Investment Grade Corporate Bond Fund. Note that it's not a junk bond ETF; rather, its holdings are considered investment grade. With the current credit crunch, however, there are increasing fears that companies will not be able to sustain interest payments on bonds. This has created a dramatic selloff, in which LQD has lost 20% (!) of its value in the last three weeks. When you consider the individual retirement accounts, pension funds, and other prudent investment accounts tied to what has been a relatively safe asset class, you can appreciate the turmoil that is spreading from Washington and Wall St. to individual households.

And junk bonds? One knowledgeable source is raising the specter of double-digit defaults, given the high leverage of the issuers. The i-Shares High Yield Corporate Bond Fund (HYG) is down over 20% since May, a stunning drop, but lately no worse than the performance of LQD. It appears that investors are running from corporates altogether, dumping the good with the bad.