Expected and Unexpected Components of Corporate Total Returns

From a recent Barclays report:

When investing in corporates, portfolio managers often think about separating the
expected and unexpected components of total returns. The expected component
reflects the current Treasury yield curve (yield level and rolldown), as well as the
current credit spread curve (OAS level and rolldown). The unexpected component
reflects the re-shaping of these curves.


A simple return attribution exercise has uncovered several features of corporate total
returns over the past 25 years:

1. Corporate total returns have been very strong, averaging 712bp per year. However,
more than 90% (644bp) of this performance was the expected component of total
return. Furthermore, 79% (509bp) of this 644bp was the expected component of
Treasury returns, with only 135bp coming from the expected component of corporate

2. The 2014 expected component of returns was much smaller (398bp) than the
historical 644bp, providing a smaller cushion against adverse unexpected returns;

3. Unexpected returns have, on average, been very small (68bp), but very volatile (637bp);

4. Unexpected returns have tended to revert on an annual basis, but this has been more
true for the Treasury component of unexpected returns than for the corporate
component of unexpected returns; and

5. While the expected component of return has declined significantly over the years, the
volatility of the unexpected component has not declined commensurately. Effectively,
now corporate investors have a much smaller buffer of protection from future negative
unexpected returns.


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