We will compute other volatility
measures, such as the standard
deviation of returns below the mean,
which is called the semideviation,
or below a target return, which is
called the downside deviation. 6
Because upside volatility is a plus
for an investment and perhaps
should not be included in the risk
calculation, these methods only factor
in downside standard deviation, rather
than the total standard deviation
that includes both downside and
upside returns. In fact, high outlier
returns, such as with defaulted bonds
and loans, as demonstrated earlier,
can have the effect of increasing
the total standard deviation more
than the average return.
Finally, we plan to examine the price
behavior of defaulted bonds for at
least the six-month period before the
default date. Time constraints did
not allow these additional tests to be
performed for this report. We hope
these additional tests and comparisons
will allow us to provide a more robust
and complete anatomy of investing in
defaulted corporate bonds and loans.
In this article, we addressed the
performance characteristics of
investing in defaulted bonds
and loans. Such research work
has rarely been done before,
given the specialized nature of
such investments and the lack
of extensive historical data.
For both defaulted bonds and loans,
we analyzed the time periods 1987-
2016 and 2006-2016, given that
the Bankruptcy Code was revised
extensively in late 2005. While
both time periods showed double-digit average rates of returns for
defaulted bonds, the time period
2006-2016 showed superior
performance, possibly due to the
Bankruptcy Code revisions. However,
the volatility of these returns,
as measured by the traditional
standard deviation, is quite high.
Pertaining to defaulted loans, the
average annual returns are much
poorer, albeit with lower volatility
than for defaulted bonds. Given that
investment returns in defaulted bonds
and loans can have extreme outliers,
we will be considering other types of
return and risk measures to compute
volatility that will address this issue.
Investment returns for defaulted
bonds were also analyzed by seniority.
Senior unsecured bonds performed
the best, with double-digit average
returns, while senior secured bonds
showed only modest high-single-digit
returns. Results for the subordinated
class were disappointing, with
negative average returns, while
discounted bonds fared much better,
albeit with a small sample size.
For the purpose of portfolio
allocation, our next work will
be expanding on this analysis
by calculating returns for
defaulted bonds and loans for
the same calendar months as
the high-yield bond index,
the Standard & Poor’s 500 index,
and possibly other benchmarks,
and then constructing an index
of defaulted bond and loan
performance and comparing
it to that of these indexes. J
1 All of the major rating agencies and
many investment banks, as well as some
academics like the authors, regularly assess
and report on the high-yield bond market.
See, for example, our quarterly and annual
reports, E. Altman & B. Kuehne, “Defaults
and Returns in the High-Yield Bond Market,”
NYU Salomon Center & Paulson & Co.
2 The N YU Salomon Center maintains
indexes on monthly returns on portfolios
of defaulted bonds (1987-present) and
defaulted loans (1996-present). Subscribers
receive a newsletter discussing the monthly
results as well as quarterly reports, “Defaults
and Returns in the High-Yield Bond
Market and Distressed Debt Markets.” For
more information, call 212-998-0701.
3 See E. Altman & A. Eberhart (1994), “Do
Seniority Provisions Protect Bondholders’
Investments?”, Journal of Portfolio
Management, Summer 1994, 67-75.
4 A graph for defaulted corporate bond
average pricing trends from 2006-
2Q2016, the period after the Bankruptcy
Code had been revised extensively, is
available from the authors upon request.
5 Most analysts include three types of defaults
in their compilations: (a) bankruptcies,
(b) bonds that have missed their interest
payments and not cured the missed
payment in the grace period (usually
30 days), and (c) distressed exchanges.
The latter securities do not usually
trade after the completed exchange.
6 Deborah Kidd, “The Sortino Ratio:
Is Downside Risk the Only Risk that
Matters?”, 2012 CFA Institute.
Edward I. Altman is the Max L. Heine Professor
Emeritus of Finance at New York University’s
Stern School of Business and director of the
Credit and Fixed Income Research Program at
the NYU Salomon Center. He is an internationally
recognized expert on corporate bankruptcy, high
yield bonds, distressed debt, and credit risk analysis,
and is an advisor to Paulson & Co., a consultant to
FINRA, and a member of the board of the Franklin
Series Funds. He was an inaugural inductee into
the Turnaround, Restructuring, and Distressed
Investing Industry Hall of Fame and is a member of
the Fixed Income Analysts Society Hall of Fame.
Robert Benhenni is a professor at Pôle Universitaire
Léonard de Vinci, Research Center, Finance
Group, in Paris; Resident Scholar at the NYU
Salomon Center; and has been a consultant to
major investment banks and hedge funds. He has
nearly 20 years’ experience at various Wall Street
firms in both hedge fund/asset management and
investment banking roles, performing portfolio
management, quantitative analysis, and risk
management. Benhenni holds a PhD in probability/
statistics from UCLA and an MBA in finance from
the University of Chicago Booth School of Business.
He can be reached at email@example.com.