The Aftermath of Investment-Grade Distress

What should one do with investment-grade bonds that begin to trade at distressed levels? This is when a portfolio manager is compelled to make the critical decision: Sell, hold, or buy? To help managers make an objective decision, the authors carefully examine the historical evidence regarding the performance of distressed investment-grade (DIG) bonds after a distress month. The historical record shows that DIG bonds have been very strong performers. On average, the 901 DIG bonds from January 1990 to July 2011 returned 51.6% over the 24 months following their distress month. They outperformed their peers by 30.1% and earned 39.8% more than comparable Treasury bonds. After adjusting for DIG bonds' ex ante higher expected excess return volatility, the authors find that DIG bonds generated approximately 81 bps a month of additional return compared with an equal risk investment in the IG Corporate Index.