Medium term equities are superior credit investments

credit investments
credit investments
When the historical pattern of autocorrelation is considered the results change dramatically. Now, the membership in the stochastic dominance efficient set becomes dependent upon the investment horizon. For periods up to 7 years stocks, corporate bonds and bills are contained in the efficient set . In other words, for risk-averse investors there is no indication that for the short to medium term equities are superior investments.

This is counterintuitive in that it contradicts the historical return experience. Over historical 7-year periods small and common stocks returned 16.3 and 11.9 percent per annum, corporate bonds 6.7 percent and treasury bills only 4.2 percent. Yet, equity portfolios possess a significantly higher volatility than bonds and bills. When introducing the Corning–Fisher expansion we also showed that investors prefer positive to negative skewness. On an annual return basis, especially broad corporate bond portfolios benefit from this preference. For holding periods between 2 and 20 years they show consistently high positive skewness of 1.0–1.6.

Assuming risk aversion it is therefore not possible to establish a clear ranking between equities and corporate bonds for investment horizons of up to 15 years. Only for longer time horizons the benefits of investing in stocks, especially diversified portfolios of common stocks, unfold. Taking into account the considerably lower volatility of diversified corporate bond portfolios in comparison to equity portfolios, corporate bonds should be an integral part of any savings plan, especially if there is uncertainty about the effective length of the investment horizon.