Credit Spread Risk

CFA Level III Fixed Income
#1

General question regarding Fixed Income readings: Why is credit spread risk more important for investment grade bonds than for high yield bonds?

The readings say that when managing a high yield bond portfolio to a benchmark (i.e., passive management), match the market value weights of each security in the benchmark. However for investment grade bond portfolios, match the overall credit spread duration of the benchmark and the weight of each security is based on the securities’ contribution to the benchmark’s overall credit spread duration.

Intuitively, I think it would be the opposite. For example, at a basic level, I would go long on high yield bonds for the higher yield (duh) and / or if I thought that the credit spread would contract during the holding period.
Can someone help correct me?

#2

Its because IG bonds have something known as credit migration risk. If these bonds are downgraded to junk, they’ll correct pretty bad. You have a lot to lose with IG bonds. With junk bonds, you already know they’re risky and thats factored into their discount rate. Junk can only go on getting junk(er) but IG binds turning to junk is a big deal and destroy your portfolio.

1 Like
#3

The above and…

You are managing to a benchmark. Why you want go long high yields ?