Reading 24, 7.1 Exhibit 17. Presented with a trend line of US Corporate vs CMBS OAS over three years, with OAS for US Corp being much higher than CMBS (and more volatile). CFA text states: ""An investor who recognized the divergent fundamental trends in the corporate and commercial real estate markets in 2013 or early 2014 could have improved portfolio returns and lowered portfolio volatility by selling (or underweighting) US corporate bonds and buying (or overweighting) US CMBS. “” I thought a higher OAS would be associated with higher returns - so higher returns could be earned by buying rather than selling US Corp bonds.
Can someone explain where I am fundamentally wrong on this, can’t think straight? Why is lower OAS better for returns.
As spreads increase, bond prices decrease, and vice-versa.
In late 2013 / early 2014 corporate bond spreads were about to increase, so the bond prices were about to drop; CMBS spreads were about to do . . . well . . . nothing, so the bond prices would remain roughly constant. By underweighting corporates and overweighting CMBSs, an investor would have had higher returns and lower volatility of returns.
lower OAS = high price apprecition = higher returns.
You have to think about it in terms of a bond perspective, not what the bond is yielding.
Thanks both for your replies. I understand it can also be the case that a bond with a high OAS, may actually return more than a bond with a low OAS, in a stable to improving economic environment?
VWJETTY, you say lower OAS = higher price appreciation = higher returns, but a bond’s return is made up of several components, including income return. Is it correct to assume that lower OAS will immediately deliver greater returns than a higher OAS bond?
I guess where I am confused is, how do we know the greater price return of the lower OAS bonds would outweigh the income return/yield of the higher OAS bond?
Possibly overthinking this, so appreciate steer.
S2000, I have always wanted to ask, is that handle a Honda car reference?!
It is.
An '01 with just under 240,000 miles on it.