A high yield is not diversification

The bond that isn’t ballast

A corporate bond looks, on the surface, like a diversifier. It sits in the “fixed income” bucket, it pays a yield above government bonds, and it is not a stock. Adding credit to a balanced portfolio feels like adding ballast.

We think that intuition is built on the wrong unit of analysis. The question is not what label an asset wears, but what risk source it actually carries.

A credit spread is mostly equity risk

The extra yield on a corporate bond — the credit spread over the risk-free rate — is compensation for the chance that the borrower’s finances deteriorate. That risk is highest in exactly the environments where equities fall: slowing growth, tightening credit conditions, rising fear of default. So credit spreads tend to widen at the same time equities draw down; historically their behaviour has had a high beta to equity returns.

Put differently, a credit allocation behaves like a levered carry — a short-volatility position: it earns a steady premium in calm times and gives much of it back precisely when diversification is most needed. That is a perfectly legitimate way to take risk, but it is equity-like risk wearing a bond’s label. It does not diversify an equity book; it duplicates it.

Diversify by risk source, not by name

This is why, in an all-weather construction, we look for genuinely different risk sources rather than different asset names. The exposures that have historically behaved differently from equities under stress are government duration — government bonds and inflation-linked bonds — together with gold and long volatility. Corporate credit is not on that list. Not because credit is “bad”, but because its risk is already represented, in cleaner form, by the equity sleeve.

It is the discipline behind the name we chose: a balanced, uncorrelated set of yield sources, assembled by risk rather than by category. It is our construction philosophy — not a verdict that other approaches are wrong — and the same instinct as building the floor before the ceiling.

A reading tool: the two brains of the curve

A short, related idea, because it travels with the same habit of mind. The short and long ends of the government curve are priced by two different logics. The two-year is, in effect, arithmetic on policy: it reflects the market’s expectation of the average overnight central-bank rate over the next two years. The ten-year is a forecast: it reflects expected long-run growth and inflation, plus a premium for the uncertainty around them.

So the shape of the curve is those two “brains” disagreeing — the front end pricing what the central bank will do, the long end pricing what the economy will become. Reading them as one number is where a great deal of confusion starts.

A high yield is compensation for a risk. The question is never how high — it is which risk, and whether you are already paid for it elsewhere.

Diversification is not a label you buy; it is a risk you genuinely do not already own. That is the test every sleeve in the book has to pass.

This article is general information and education — not investment advice, a personal recommendation, or a financial service within the meaning of the Swiss Financial Services Act (FinSA/LSerFi) — and it does not take account of your circumstances. Diversification does not ensure a profit or protect against loss. See who we serve and how we work.