Portfolio with a higher credit income stream
The difference is that one cannot hedge corporate bond risk in the same easy way as equity risk. In addition to that the inclusion of corporate bonds in a portfolio can massively influence the handling of this portfolio.
Dynamic portfolio protection is a path-dependent strategy. The amount of risks taken depends very much on the development of the portfolio value. If the risk budget grows, more risks can be taken. If it falls, risks have to be reduced. One source that influences portfolio value is the income stream generated by coupons, interest paid on cash and dividends. The higher yielding corporate bonds provide the portfolio with a higher income stream which affects the risk budget positively. Therefore, corporate bonds constantly support the risk-taking ability of a portfolio. On the other hand, however, the portfolio manager has to take account of the risk of a general spread-widening as well as single name risk.
The best way to mitigate single issuer risk is undoubtedly diversification. Given a bond portfolio with an average spread of 80 bp, we assume that whenever a bond blows up its price falls to an average of 60. The maximum percentage of blow-ups you can afford is 2 percent of your portfolio just to break even. If in a portfolio with 50 names more than one bad investment decision occurs, the expected excess return over government bonds turns into a loss.
