Corporate bonds

How it got riskier to own high-quality corporate bonds

“It’s actually quite smart that they issued a lot of long-term debt at very low interest rates,” Pierson said. “I’m not saying they’re completely immune to rising interest rates, but it’s been good financial management.”

The other notable change in investment grade corporate bonds is a deterioration in overall quality. In 2007, 27% of the total value of bonds issued by companies in the Standard & Poor’s 500-stock index were rated BBB, the lowest tier of investment grade. Today, 50% of the market value of S.&P. 500 bonds have this rating.

Mariarosa Verde, head of credit at bond rating firm Moody’s Investors Services, said the ratings downgrade is largely the result of corporate intent. Companies that once had sterling ratings are “strategically deciding to take on more leverage,” she said, perhaps to fund a merger or acquisition.

Bayer, CVS, General Mills and AT&T are among traders whose investment grade bond ratings have fallen as they borrowed more.

When bonds are downgraded due to targeted corporate borrowing, it “can be a good time to invest,” Ms Emery said, assuming a company has the will and the cash to pay off that debt and get back up. the rating scale. This value-seeking approach has helped Dodge & Cox Income achieve a 4.9% annualized return over the past 10 years. That was one percentage point ahead of the benchmark aggregate index.

Nonetheless, the bulge in BBB bonds could be a recipe for more volatility in the next downturn. According to Moody’s, in a year of recession, the lowest 10% of investment-grade bonds become fallen angels, the industry term for bonds downgraded to junk status. “In the next recession, there will be more top-quality companies at risk of becoming fallen angels than at any time in the past,” Ms. Verde said.

This could hit index funds the hardest. Once a bond has gone from investment grade to high yield, high-quality indices – and the funds that track them – are usually bound to quickly dump the bond, forcing the funds to sell when the prices have fallen. Actively managed funds are generally not bound by such a strict sell rule.