Fixed Income’s Low-Risk Anomaly

Modern financial theory now includes the existence of many anomalies that shouldn’t exist if investors were perfectly rational and markets were perfectly efficient.

Perhaps the most important anomaly is the persistent and pervasive momentum premium. Among the others are the low-volatility anomaly (low-volatility stocks have outperformed high-volatility stocks) and the poor performance of extreme small growth stocks, IPOs, penny stocks and stocks in bankruptcy. And while there is no debate about the equity or the small-cap premium being anomalies, there are many behavioral finance people who believe the value premium is an anomaly.

Interestingly, there hasn’t been much debate about the default and term premiums in bonds. Yet investors have historically received very little in the way of compensation for taking default risk, and not much of a premium for taking term risk once you get beyond the intermediate term.

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