Investing In Investment-Grade Corporate Bonds
Have you thought about investing in investment-grade corporate bonds? Well, now might be the time to start thinking about investing in these bonds.
With savings interest rates declining and ten-year Treasury notes paying very low interest rates, I started looking around for better yields. Investment-grade corporate bonds currently have an average yield of 8.4%. This is more than 5% of the yield on ten-year Treasuries.
What are investment-grade corporate bonds?
Let’s start by answering the question, what is a bond? Basically, a bond is a loan issued by a corporation, a government or some other entity. If a company needs to borrow money, they can borrow it by issuing a bond which sets forth the repayment terms like a mortgage.
The person who loans money to a company or the government through a bond is called a bondholder. In exchange for the loan, the issuer of the bond will pay interest to the bondholder over time and then return the principal at the end of the bond term.
What makes bonds investment-grade corporate bonds?
First of all, these bonds are issued by corporations or other corporate entities, as compared to government bonds. So the real question is, what makes a corporate bond investment grade?
There are three primary corporate evaluation entities that assign ratings to bonds issued by companies.
- Moody’s Investors Services
- Fitch IBCA
- Standard & Poor’s Rating Services
These entities evaluate the company’s financial position to determine how likely the company will be to pay back the bondholders. Each of these entities has a different ratings system, but here are the ratings used by Moody’s Investors Services.
- Aaa – Best quality, with smallest degree of investment risk.
- Aa – High quality by all standards; together with the Aaa group they comprise what are generally known as high-grade bonds.
- A – Possess many favorable investment attributes. Considered as upper-medium-grade obligations.
- Baa – Medium-grade obligations (neither highly protected nor poorly secured). Bonds rated Baa and above are considered investment grade.
- Ba – Have speculative elements; futures are not as well-assured. Bonds rated Ba and below are generally considered speculative.
- B – Generally lack characteristics of a desirable investment.
- Caa – Bonds of poor standing.
- C – Lowest rated class of bonds, with extremely poor prospects of ever attaining any real investment standing.
As you can see, any bonds having a rating of Baa or above are deemed to be investment grade corporate bonds. But, don’t think that investment grade means that these bonds are without risk. That is not the case. All securities come with risk. The question that you must ask yourself is whether the upside potential outweighs the risk.
In fact, the reason why these corporate bonds are paying such high yields is because people perceive them as having a lot of risk. People believe that there is a higher risk of these companies going bankrupt or generally being unable to payback their bondholders.
What is the best way to invest in investment grade corporate bonds?
The are a several ways you can invest in corporate bonds, but the two most common ways are to buy them individually through a broker or by investing in bond mutual funds.
Investing in bond mutual funds is probably the better way to invest in investment grade corporate bonds. If you buy bonds through a broker, you will pay higher commissions and expenses and be less diversified.
Bond funds will hold many corporate bonds. This will help you to reduce your risk of not being paid back.
Do you think investing in investment grade corporate bonds is a good idea? Please share your thoughts in the comments below.
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