Return Free Risk: A Picture Book

Once upon a time there was an asset class called high yield debt. It consisted of all the lowest quality bonds issued by all the lowest quality companies. Companies like Frontier Communications and Sprint and Valeant Pharmaceuticals.

And yet, because There Is No Alternative but to buy risk assets these days, particularly for Yield-Starved Fixed Income Investors, in aggregate this debt traded at yields well below the historical average.

 

118_HY_Spreads

 

You see, what the Yield Starved Fixed Income Investors had forgotten was that high yield debt returns are (badly) negatively skewed.

 

118_HY_Loss_Potential

 

And so what the Yield Starved Fixed Income Investors had bought was return free risk.

 

118_Spred_Per_Turn_Leverage

 

118_Yield_Per_Turn_Leverage

(Charts from a presentation by Troob Capital Management)

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