Last week, I outlined how to construct a portfolio of stocks and high-quality bonds to replicate the returns of high-yield corporate bonds. This week I’m tackling investment-grade corporate bonds.The same basic logic as last week holds: There’s not much unique about investment-grade corporate bonds that you can’t achieve with a diversified portfolio of stocks and high-quality bonds. The only difference is you don’t need as much in stocks to replicate the returns of investment-grade corporate bonds as you do with high-yield corporate bonds. This is because high-yield corporate bonds are more similar to stocks because they both have substantial exposure to default risk. Investment-grade corporate bonds have less default risk and therefore aren’t as similar to stocks.Here are the results. We used the same funds as we did last week: Vanguard’s S&P 500 fund (VFINX) for stocks and Vanguard’s Intermediate-Term Treasury fund (VFITX) for high-quality bonds. This time, we’ll use Vanguard’s Intermediate-Term Investment Grade fund (VFICX) as the bogey. The period is the longest available: December 1993 (first full month of returns for VFICX) through April 2013.
In this case, an allocation of 12 percent in VFINX and 88 percent in VFITX does the best job of tracking investment-grade corporate bonds. The result is similar to what we saw last week with high-yield bonds: You can effectively get the same returns of investment-grade corporate bonds with less risk (and also more tax efficiency if the positions would be held in a taxable account).Random Links and Commentary of the WeekGame 7 is here! It’s been a great NBA Finals, and I can’t wait to see how it concludes tonight.