Risks and Returns of Low-Grade Bonds: An Update (Reprint 027)

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Abstract
This paper updates previous analyses of the risks and returns of low-grade bonds to include 1990, a year during which the low-grade bond market experienced dramatic changes. The annual return of 8.7 percent for low-grade bonds over the 1977-1990 period is lower than the returns on long-term Treasury bonds, long-term corporate bonds, the S&P 500 or small stocks over the same span. Much of this poor relative performance can be traced to the 1989-1990 period when low-grade bonds realized an average annual loss of 5.4 percent. During this same period, small stock prices also fell dramatically. The high degree of correlation between the returns of low-grade bonds and small stock during the entire period of analysis, but especially in the latter half of 1990, suggests that a factor common to both small stocks and low-grade bonds can explain a significant portion of the losses of low-grade bonds over this latter period.
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