What Is Below Investment Grade Fixed Income?
- Debt or bond issuers are given credit ratings by the rating agencies of Standard & Poors and/or Moody's. The credit ratings use letter grades to indicate the ability of the bond issuer to pay interest and principal on the debt as scheduled. Starting with the highest credit rating, Moody's uses the scale Aaa, Aa, A,, Baa, Ba, B, Caa, Ca and C. The similar list from S&P goes AAA, AA, A, BBB, BB, B, CCC, CC, C and D. Credit ratings of Baa/BBB and above are considered to be investment grade. Ratings below Baa/BBB are non-investment grade bond issuers.
- Non-investment grade debt issuers are often well-known major corporations. Ford Motor Credit, cable company Charter Communications, cell phone service provider Nextel Communications and Motors Liquidation Company -- the former General Motors -- are all non-investment grade bond issuers. Countries also have credit ratings, and if a country's credit rating is low enough, it will be considered below investment grade. For example, Uruguay has a credit rating of BB from Standard & Poors.
- A below investment grade credit rating means that the rating agencies believe the debt issuer has a higher probability of defaulting on the payment of its debt on either interest or principal payments. Investment grade debt is not considered risky for default. For a non-investment grade company to borrow money, they must pay a higher rate of interest to entice investors to accept the higher level of risk. Non-investment grade fixed income investments are what the market refers to when discussing high-yield bonds.
- Below investment grade bonds provide investors two ways to profit. The higher interest rates paid by non-investment grade bonds are just one benefit. Another is that these bonds will increase in market value if one of the rating agencies gives the company a ratings upgrade. Non-investment grade companies tend to have better results if the economy is growing. High yield bonds are one way to profit from a strong or turnaround economy.
- For most investors a high yield bond fund is a better choice than trying to evaluate and buy individual high yield bonds. A fund provides exposure to a diversified portfolio of bonds, and default problems with one issuer will not have a great effect on the overall value of the investment. Types of high yield bond funds are mutual funds, closed-end funds and exchange traded funds -- ETF -- types. Evaluating the funds average credit quality is a main criteria for selecting a high yield bond fund.