UBS Wealth Management Research has published a study into the growing corporate bond market, which aims to demystify the increasingly important sector for retail investors.

The study analyzes the structural trends and product innovations in the market for corporate bonds and their consequences for the portfolios of private investors. It notes that the corporate bond trade is just as large and important as the U.S. equity market. The U.S. bond market is the largest and most liquid in the world. However, UBS says the introduction of the euro has gradually led the market for corporate bonds in Europe to become more important and more liquid.

“The proportion of outstanding bonds ranked in the highest rating class by the rating agencies is growing ever smaller,” UBS says. “Although the financing requirements of companies outside of the financial sector has risen, issuers in the financial sector account for the largest share of new issues – and this share is increasing.”

Changes in the market and the reasons behind them are having an effect on the optimal portfolio structure, UBS adds. “Many private investors have concentrated their assets in just a handful of bonds with a very high rating,” it notes. “In doing so, they are foregoing higher interest rates. The portfolio’s yield can be increased without added risk by means of efficient diversification.”

“Most sectors of the economy are cyclical. The yield premium on corporate bonds, which serves as compensation for the risk of payment default, is likewise cyclical,” UBS explains. “The strength of economic growth and the health of corporate balance sheets are decisive factors influencing the upward or downward movement of yields. This relationship can be used to create an investment strategy that anticipates credit risk.”

Also, derivatives and alternative investment instruments can be used as a practical means of achieving credit risk diversification and positioning with respect to the credit cycle, it adds. “These products were first used by institutional investors to manage their corporate credit risk via a transfer to capital markets,” it reports. “More and more credit derivates and structured products are becoming available to meet the needs of private investors. Credit derivates are being used more frequently in the fund sector, creating new and attractive investment strategies.”

“The broader investment range and changing conditions are increasingly affecting investment decisions. Only well-informed private investors will be able to achieve above-average yields,” it concludes.