[The data on corporate bond returns in this post were updated in January of 2022.]

Many folks visit Mindfully Investing to check out the historical returns data for various asset classes.  So, today’s post is another installment in my ongoing expansion of the historical returns data sets provided here at Mindfully Investing.  In this case, I want to take a look at the history of corporate bond returns.

I haven’t written much about corporate bonds in the past, mainly because corporate bonds tend to have relatively low yet predictable returns, but with higher risks than relatively safe government bonds.  So, if you’re adding risk to your portfolio to beat the returns of government bonds, stocks are likely a better choice than corporate bonds. Alternatively, consider diversifying into mortgage notes or note funds backed by residential real estate. However, this statement is a considerable oversimplification, which is why I wanted to take a closer look at the historical returns (and risks) for corporate bonds.

What Is A Corporate Bond?

The major asset classes addressed at Mindfully Investing are stocks, bonds, and cash.  A bond represents a loan from the investor to the bond issuer (for example, the U.S. government).  The bond issuer pays interest to the investor at a specified amount and frequency over the life of the loan and then pays back the loan principal (the “face value” of the bond) at a specified future date (the “maturity date”).

A corporate bond is when a private company or corporation requests such loans on the open market.  Corporate bonds are typically issued in blocks of $1,000 in face value.  Like all bonds, the corporate variety can be traded in the bond markets after the initial purchase, which impacts the price of the bond over time, but not its original face value.  As with stocks, you can also buy baskets of corporate bonds through mutual funds or exchange-traded funds (ETFs).

As I already alluded, corporate bonds generally have higher volatility, and therefore higher implied risks, than U.S. government bonds.   So, corporate bond interest rates (yields) are almost always higher than government bond yields, even for companies with excellent credit ratings.  The companies issuing corporate bonds are evaluated for risks like non-payment of interest or loan default by one or more of three U.S. rating agencies: Standard & Poor’s Global Ratings, Moody’s Investor Services, and Fitch Ratings.  Confusingly, each agency has its own rating system, but generally, the highest quality bonds are given some form of “triple-A” rating (like AAA).

Here’s a generic list of bond ratings that gives you an idea of the hierarchy of corporate bond quality:

• AAA – highest quality
• AA
• A
• BBB
• BB
• CCC
• CC
• C
• D – lowest quality

So, a bond with a BB rating has a higher risk of default than a bond with a BBB rating. If you want to see all the rating categories from each rating agency, Fidelity presents a complete list here.  Bonds rated “BB” and lower are called “high-yield” bonds because they typically pay higher interest than similar high-quality bonds.  But they’re also called “junk” bonds because of the greater risks implied by the lowest ratings.  Conversely, bonds above the BB level are called “investment-grade” bonds due to the lower implied risks.

Historical Returns of Corporate Bonds

The longest continuous record of annual returns I could find for any type of corporate bond goes back to 1928, as presented by Aswath Damodaran at New York University’s Stern School of Business.  This includes data for AAA-rated bonds and BBB-rated bonds, which represent both ends of the spectrum of investment-grade bonds.

Based on these data, the nominal (not inflation-adjusted) average annualized return (also known as Compound Annual Growth Rate; CAGR) for investment-grade bonds from 1928 through 2021 was:

• AAA Rated Corporate Bonds – 5.8%
• BBB Rated Corporate Bonds – 6.9%

Also, I found Portfolio Visualizer data going back to 1979 for lower quality junk bonds.  Although the shorter period clouds direct comparisons with the investment-grade bond returns above, the nominal average annualized return for junk bonds since 1979 was:

• Junk Bonds – 7.9%

However, these are all long-term averages, which means that over shorter periods corporate bond returns have diverged substantially from these averages.  This table shows some additional descriptive statistics for the nominal annual returns from AAA and BBB rated corporate bonds back to 1928 and junk bonds back to 1979.

As we would expect, lower-quality investment-grade bonds (BBB) and junk bonds have experienced more variable annual returns than AAA bonds.  On average in this period, AAA bond returns were outpaced by BBB bond returns by about 1.1%.  Thus, investors in lower-quality bonds were compensated for the additional risks implied by lower ratings.

You may be interested in determining annualized corporate bond returns for specific historical periods.  Similar to my historical return calculators for stocks, bonds, and cash, these three calculators provide annualized corporate bond returns (both nominal and inflation-adjusted) between any two dates based on data from Damodaran (back to 1928 for AAA and BBB bonds) and Portfolio Visualizer (back to 1979 for junk bonds).

Historical Risks for Corporate Bonds

Volatility, as measured by the standard deviation of the routine ups and downs of returns over time, is the most common (but somewhat flawed) measure of investment risk.  Because higher returns are usually associated with higher risks of losing money, it’s prudent to evaluate the long-term balance of both returns and risks for every investment.

Unfortunately, we don’t have continuous volatility data going back to 1928 as we do for returns data.  In fact, I had great difficulty finding suitable corporate bond volatility data going back more than 10 years.  However, I eventually found a 2019 research paper Bekaert and De Santis that examined the volatility of various corporate bonds from 1998 to 2018 (a 21-year history).  They found the following standard deviations for AAA and BBB bond returns:

• AAA bonds – 6.7%
• BBB bonds – 6.2%

It’s puzzling that BBB bonds had lower volatility than AAA bonds in this period.  But this may simply show that, in the uncertain world of investing, short-term results don’t necessarily follow long-term historical trends.

And to round out the field, from Portfolio Visualizer data, we can say that the volatility of junk bonds from 1979 to 2019 was:

• Junk bonds – 7.3%

In this case, junk bond volatility is higher than investment-grade volatility above, as we would expect.

Corporate Bond Returns/Risks as Compared to Other Major Assets

So, now we have decent estimates of both returns and risks for corporate bonds across the full range of quality ratings.  But how do those data compare to the balance of returns and risks available from other asset classes?  Here’s a graph plotting risk versus returns for many of the asset classes and subclasses that I’ve written about here at Mindfully Investing.

The graph shows results from 1998 to 2018, which is the same period used in Bekaert and De Santis research.  The squares represent the actual returns (CAGR) and risks (standard deviation) in this period, and the round dots represent the “theoretical”² or expected relationship between risk and returns for these asset classes.  Actual returns and risk data are from Portfolio Visualizer, except for AAA and BBB corporate bonds, which are from the Bekaert and De Santis study.

The best-fit line for the theoretical relationship between these asset classes differs substantially from the best-fit line for the actual data for the 21 years from 1998 to 2018, particularly at the high-risk (right side) of the graph.  Put another way, the actual returns in this period for emerging market stocks, developed market stocks, and U.S. large-cap stocks were much lower than generic expectations for these assets.  Conversely, the returns for BBB corporate bonds were notably higher than generic expectations.

All this suggests that the data from 1998 to 2018 could be a poor illustration of the typical long-term relationship between these assets.  Portfolio Visualizer contains corporate bond data (with no differentiation of AAA, BBB, or other types of investment-grade bonds) extending back to 2003.  So, I built a similar graph covering the almost 18-year period from the start of 2003 through to May 2020.

Although this period starts only five years after the previous graph, the relationship based on actual data is much more closely aligned with generic expectations for these assets.  Further, the unusual performance of investment-grade corporate bonds (particularly BBB) over the two decades starting in 1998 disappears if we start the calculation just a few years later.

The decadal variations in risks/returns shouldn’t be surprising because we know that the returns/risks of any given asset vary substantially over time.    A good example of corporate bond risk/return variations is provided by these two graphs from an Alliance Bernstein study back in 2013 of junk bond risks/returns.

So, armed with the detailed data and associated caveats we can make some broad generalizations about the risks and returns of corporate bonds as compared to other asset classes.  In general, we can rank the asset classes in terms of long-term risks and returns in increasing order:

• • Cash
  • Government bonds
  • Investment-grade corporate bonds
  • Junk (or high-yield) corporate bonds
  • U.S. stocks (as represented by large caps)
  • Developed market stocks³
  • Emerging market stocks

Focusing more on today’s topic, we can also say that, over the long-term, corporate bonds generally produce about a half to three-quarters of the returns of U.S. stocks, but at times, they can outperform stocks, as the graphs above demonstrate.  More interestingly, corporate bonds, even junk bonds, tend to have about half the volatility of stocks.  Put more simply, corporate bonds tend to have a better return to risk ratio than stocks.

However, the last graph shows that corporate bond volatility can abruptly increase when the markets are in turmoil.  From 2007 to 2009, junk bond volatility spiked by about a factor of three, from 5% to nearly 15%!  Volatility of only 5% is certainly typical of sedate bonds, but 15% volatility is much closer to what we would normally expect for stocks.

Conclusions

The history of corporate bond returns and risks suggests two potential perspectives.  If you are risk-averse and are starting with a portfolio that contains mostly government bonds, adding some corporate bonds (even junk bonds) may be a prudent way to moderately boost your long-term returns without adding huge risks.  But if you are more comfortable with risk (that is, you’re a mindful investor) and already have plenty of stocks in your portfolio, there’s no compelling argument for adding corporate bonds, beyond the diffuse benefits of generic diversification.  That’s because corporate bonds (particularly investment-grade bonds) have rarely exceeded stock returns, while sometimes generating stock-like volatilities (particularly junk bonds).

Given this blog is about mindful investing, I see things from the second perspective.  But I have to say that this examination of corporate bonds has piqued my interest in BBB and junk bonds as a potentially better form of portfolio ballast than government bonds.  Over the long term, corporate bonds have shown a higher return potential than government bonds, with volatilities that are usually well below that of stocks.  But because of the very low expected future returns for all kinds of bonds, I wouldn’t add corporate bonds (or bonds of any kind) to my portfolio until interest rates and bond yields are substantially higher than they are today, for reasons I’ve already summarized in this recent post.

1 – The arithmetic average of annual returns differs from annualized returns (CAGR) as discussed more here.

2 – By “theoretical”, I mean that a quick review of any basic investing references shows that professionals assume a certain hierarchy of risks and returns among these asset classes based on historical data and experience.  Nonetheless, it’s widely understood that the actual hierarchy of risks or returns in any given period can vary substantially from this theoretical assumption.  

3 – Note that in the periods examined in this post, developed-market stocks did not strictly follow this hierarchy because they had higher risks than U.S. stocks but lower returns.  Further, it’s been so long since developed-market stock returns beat U.S. stock returns, that some experienced investors would likely reverse the hierarchy of these two assets.