Asset managers turn to corporate bonds

A couple of days after David Swensen recommended corporate credits, a survey by the FT indicated that high-grade corporate bonds are set to outperform other asset classes in 2009.

More than half those surveyed said high-quality corporate credit was trading at cheap levels and that this was the asset class most likely to see a rally in 2009. High-quality corporate bonds had been oversold after investors had abandoned corporate credit of all grades over the past year in favor of the safest and most liquid assets, such as government bonds.

Credit market prices are consistent with an unprecedented risk of default, even for the highest quality corporate bonds.

US investment-grade corporate bond prices, for example, imply a cumulative default rate of 36 per cent over five years, assuming a typical recovery of 40 cents in the dollar. This is more than 7.5 times higher than the worst default rate in any previous five-year period.

In contrast, government bonds were the least-favored asset class, with many of the 30 leading asset managers and strategists surveyed arguing that yields had plummeted too far in 2008, prompting talk of a possible price bubble.