When talking with investors, I often hear the terms “corporate” and “credit” used interchangeably to describe a certain segment of the bond market. But while these designations are often lumped together, they actually refer to two different types of bonds.
To understand the difference, think about the stock market. When you buy a common stock, you’re buying an ownership stake in a corporation. Many of these same corporations, regardless of where they are headquartered, issue debt in US dollars, and this debt is categorized as “corporate.” Easy enough. Where it gets tricky is that there are a number of other types of entities that also issue USD denominated debt. The term “credit” captures these other issuers, along with the debt of corporations.
To help us understand the distinction, let’s examine the Barclays Capital U.S. Credit Bond Index, the most common benchmark used to measure the US credit bond market. Originally this index was corporate-only, as almost all the issuers included in it were corporations that came to the US bond market to raise money.
Over the last decade, however, we increasingly saw other types of entities (think foreign agencies and authorities, for instance) issue bonds in US dollars to lower their funding costs and broaden their investor base.
In June 2000, the index was changed from “Corporate” to “Credit” in order to more accurately reflect the evolution of the US bond market. As you can see from the graph below, about 80% of the credit index is now corporate issuers, with the remaining 20% issued by other types of borrowers. In general, currency and market of issuance, rather than where an issuer is from, determine whether bonds are included in US credit indices.
Let’s take a closer look at the type of issuers included in the Barclays Capital U.S. Credit Bond Index:
- Foreign Agencies – Bonds issued by agencies that are owned or guaranteed by a single government. Similar to Fannie Mae and Freddie Mac, these agencies receive government support to fulfill a social or financial mission of the government. Petrobras, the Brazilian state owned oil company, falls into this category.
- Foreign Local Authorities– Foreign municipalities, like the Canadian provinces of Ontario and Quebec, issue bonds to access the large pool of US investors.
- Sovereigns – Foreign governments (think Brazil, Mexico and Italy, for instance,) tap the US bond market.
- Supranational Agencies – Agencies that are sponsored by more than one central government. Bonds from these agencies typically have AAA credit ratings, as the bonds are backed by multiple government guarantees. For example the Asian Development Bank, which finances development projects in Asia, is sponsored by 67 different countries.
- Taxable Municipals – These are taxable bonds issued by municipalities. The issuance of these bonds increased during 2009 to 2010 as more state and local governments borrowed money under the Build America Bond program, part of the American Recovery and Reinvestment Act of 2009.
Corporate or credit – what’s the right choice for an investor? It all depends on what kind of exposure they want. Some investors prefer corporate debt because they want exposure that better matches up to their equity portfolio, or perhaps they have a market view that focuses on corporate debt specifically. Other investors may prefer credit as it is a larger, more diversified sector and more fully captures the US bond market. Remember that corporate bonds are included in credit indexes, and their returns are historically highly correlated. If an investor is indifferent between the two, then they should focus on other factors such as the liquidity, cost, and transparency of the investment vehicles they are evaluating.
1: Source Barclays Capital as of 6/30/2011
Indexes are unmanaged and one cannot invest directly in an index. Index constituents are subject to change.
Bonds and bond funds will decrease in value as interest rates rise.