Futures on investment-grade and high-yield corporate bonds open new avenues for investors to access credit products. These futures provide a cost-effective way for investors to gain both long and short (hedging) positions in these markets, and make it easier to incorporate credit products into diversified long-only portfolios, like those using risk parity strategies.
But how do the Bloomberg U.S. Corporate Investment Grade Index and the Bloomberg U.S. Corporate High Yield Very Liquid Index compare with traditional investments such as the S&P 500 and U.S. Treasuries in terms of historical volatility, correlation and risk-adjusted returns? The answers to these questions may come as a surprise.
Volatility
One might think that high-yield bonds are inherently more volatile than their investment- grade counterparts. However, for most this century, the opposite has been true. With a few exceptions, realized volatility on the Bloomberg U.S. Corporate High Yield Very Liquid Index (and pre-2010 the Bloomberg U.S. Corporate High Yield Index) has generally been lower than that of either the Bloomberg U.S. Corporate Investment Grade Index or 10Y U.S. Treasury futures. But there have been periods where high-yield bonds have been more volatile than their investment-grade counterparts. These periods include:
2001-2002: The Tech Wreck recession
2008-2009: The Global Financial Crisis
2011-2012: The Eurozone Debt Crisis
2015-2016: The Collapse of Oil Prices
2020: The COVID pandemic
The main reason why high-yield bonds tend to have less volatility comes down to duration. High-yield bonds typically have about half the duration of their investment-grade counterparts. Currently, the option-adjusted duration of the Bloomberg U.S. Corporate Investment Grade Index is 6.79 years, more than twice as long as the Bloomberg U.S. Corporate High Yield Very Liquid Index’s 3.30 years. Only during periods of acute credit market stress, which normally comes along with sharp and volatile declines in equity markets, have high-yield bonds been more volatile than their investment-grade counterparts (Figure 1).
Figure 1: Investment-grade corporate bonds are usually more volatile than high-yield bonds
Correlation
This brings us to the second reason: correlation. Investment-grade and high-yield bonds have very different correlations with U.S. Treasury and equity markets.
Investment-grade bonds typically have very high correlations with U.S. Treasuries and rather weak correlations with the S&P 500. Moreover, investment-grade corporate bonds typically have a stronger correlation to Treasuries than they do to high-yield corporate bonds (Figure 2). Their correlations with Treasuries can decline during periods of acute market stress such as during the onset of the pandemic in 2020 or even, on a smaller scale, during the market’s early April 2025 sell-off.
Figure 2:Investment-grade bonds correlate much more highly with Treasuries than equities
By contrast, the Bloomberg U.S. Corporate High Yield Very Liquid Index’s correlation is nearly always higher with the S&P 500 than with U.S. Treasuries (Figure 3). In short, high- yield bonds act more like equities than investment-grade bonds or Treasuries, but they resemble low-risk stocks due to their relatively short durations.
Figure 3: High-yield bonds are usually more correlated with stocks than with Treasuries
The correlations of investment-grade and high-yield bonds to the S&P 500 are influenced by the changing nature of the S&P 500-U.S. Treasury correlation itself. Both bonds have higher (meaning more positive/less negative) correlation to equities than U.S. Treasuries (Figure 4).
Figure 4: Corporate bonds are more positively/less negatively correlated with stocks than Treasuries
The Treasury-equity index correlation was negative for most of the period from 2001 to 2020 when investors’ main concerns were recession, defaults and deflation. The S&P 500-Treasury correlation did, however, flip back to positive following the post-pandemic wave of inflation that struck the U.S. in 2021. That correlation has gone back to being slightly negative now that inflation has subsided from its highs. Over long periods of time, inflation appears to be a major driver of the equity-Treasury correlation that in turn influences the behavior of both investment-grade and high-yield corporate bonds (Figure 5).
Figure 5: Inflation rates are a key determinant of the Treasury-Equity correlation
Risk-Adjusted Returns
If one looks at raw (unadjusted) investment returns, equities appear to dominate (Figure 6). But this is mainly because equity markets have historically been much riskier than bond markets (Figure 7).
Figure 6: Equities dominate raw (unadjusted) returns because they are riskier investments
Figure 7: Equity volatility is nearly always higher than even long-term fixed income volatility
If one risk adjusts the returns to an ex-ante (no look ahead bias) volatility of 10%, the comparative returns look much different. To do this, we calculate a trailing one-year realized volatility and then adjust the next day’s return to a 10% risk level. For example, if the S&P 500 had a 20% realized volatility for the past year, we would multiply the next day’s return by one half (10% target /20% realized). Or, if the U.S. Treasury had a 5% realized volatility for the past year, we would double the next day’s return (10% target / 5% realized).
For futures contracts on the S&P 500 and the U.S. Treasury, this is easy since they are already in excess return over the cost of funding. For the historical returns of the Bloomberg U.S. Corporate Investment Grade Index and the Bloomberg U.S. Corporate High Yield Very Liquid Index, this requires one additional step: subtracting the risk-free rate from the total return index to put it into excess return, making it comparable to the return of a futures contract.
Lastly, after adjusting the risk of the various instruments, we add back the risk-free rate (which we assume to be the return of three-month T-Bills) to all of the series, essentially giving us the return of a continuously rolled, fully funded futures contract.
These results show that since 2000, on a risk-adjusted basis, the Bloomberg U.S. Corporate Investment Grade Index has the highest risk-adjusted return, followed by the Bloomberg U.S. Corporate High Yield Very Liquid Index. By contrast, the S&P 500 is in the middle of the pack, not as strong as 5Y or 10Y U.S. Treasuries on a risk-adjusted basis but above 2Y and 30Y U.S. Treasuries (Figure 8). The outperformance of corporate bonds on a risk-adjusted basis might reflect the inherent diversification present in corporate bonds since they correlate to both Treasuries and equities. As we will discuss further down in the article , negative correlations between equities and Treasuries for most of this century have enhanced the risk-adjusted returns of long-only portfolios that blend equities and bonds.
Figure 8: Corporate bonds have done exceptionally well on a risk-adjusted basis
Prior to the advent of futures on investment-grade and high-yield corporate bonds, including these instruments in risk-parity portfolios would have been difficult owing to the challenge of rescaling their risk to higher (or lower) levels. Futures markets, however, have long made it easy for purveyors of risk-parity strategies to scale risk to desired levels.
Within the risk parity space specifically, and the long-only 60/40 equity/bond realm more generally, negative correlation between equities and Treasuries is highly desirable as the gains and losses in stocks and bonds tend to offset one another during periods of negative correlation. By contrast, the kind of positive correlation that tends to manifest itself during periods of higher inflation tends to diminish the diversification inherent in such portfolios. See Figure 9 as an example and look at the gap between the 10Y-rolling information ratio (annualized return/annualized standard deviation of returns) for a mixed 50-50 equity risk-bond risk portfolio compared to investments exclusively in the S&P 500 or U.S. Treasuries. The gap between the risk-adjusted return of the mixed portfolio relative to purely equity or Treasury investments was much greater during the negative Treasury-equity correlation period of the 2010s than it was during the positive correlation environment that prevailed before 1998 (Figure 9).
Figure 9: Negative S&P 500-U.S. Treasury correlations were a boon to long-only investors during the 2010s who blended stocks and bonds together in their portfolios
If the remainder of the 2020s sees subsequent waves of inflation because of rising protectionism, increasing military spending, the energy transition, geopolitical factors and supply chain disruptions, investors may wish to seek out additional sources of portfolio diversification.
Although correlated to both equities and Treasuries, corporate bonds have shown themselves to contribute to portfolio diversification. Now that they can be scaled to different risk levels with futures contracts, their potential inclusion to a diversified risk-parity portfolio could be much easier than before.
In addition to their potential use in long-only portfolios, futures contracts can also allow corporate bond portfolio managers to reduce portfolio risk by selling futures without needing to sell the underlying corporate bonds in their portfolios. Moreover, they can allow others, such as proprietary traders and hedge funds, to gain short exposure.
Two months ago, we wrote about the extraordinary narrowness of high yield spreads with respect to U.S. Treasuries. (See our article here) Since then, option adjusted high yield spreads have widened from 2.5% over Treasuries of comparable maturity to 4.12%. However, they still remain extremely narrow by historical standards despite rising default rates for both credit card loans and auto loans (Figures 10 and 11) as well as rising volatility in equity markets.
Figure 10: Credit spreads are still narrow given rising credit card delinquency
Figure 11: Figure 9: Credit spreads are still narrow given rising auto loan delinquency
Bottom Line
- High-yield bonds usually show less realized volatility than investment-grade bonds owing to much shorter durations
- Investment-grade bonds behave much more like U.S. Treasuries than high- yield bonds, which show much stronger correlations with S&P 500
- Investment-grade and especially high-yield bonds show a consistently more positive/less negative correlation with equities than do U.S. Treasuries
- The Treasury-S&P 500 correlation depends to a large extent on inflation rates.
- Lower equity-bond correlations are better for long only 60/40 and risk parity portfolios
- Equities dominate bonds in raw total returns because they are riskier investments
- On a risk-adjusted basis corporate bonds have done better than equities or Treasuries
- Futures on investment grade corporate and high-yield bonds make it possible to scale risk levels up or down to meet portfolio needs
- Even after the recent equity market correction, credit spreads remain rather narrow historically
Trading Credit futures
There are several ways to better manage corporate bond portfolios.
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
