Many investors look to investment-grade bonds for safe, reliable income.
Investment-grade refers to a bond’s credit quality. A bond’s creditworthiness is typically evaluated by Moody’s, Standard & Poor’s, and Fitch. The bond’s credit rating is determined by the rating agency’s opinion that the issuer of the bond will be able to make interest payments and then repay the loan at maturity.
The creditworthiness also affects the bond’s yield. Bonds with lower ratings generally offer higher yields to compensate investors for the additional risk.
Investment-grade bonds are those with a rating of BBB- (on the Standard & Poor’s and Fitch scale) or Baa3 (on Moody’s) or better. Bonds with lower ratings are often referred to as high yield or junk bonds.
How These Bonds Fit Into the Fixed Income Ecosystem
Investors typically group bond ratings into two major categories: investment-grade and high yield. Investment-grade includes bonds rated Baa3/BBB- or better, while high yield includes bonds rated Ba1/BB+ and lower.
Why Forgo Yield to Keep Quality High?
There are still uncertainties in U.S. markets. Inflation has eased but remains stubbornly high, the market isn’t certain about the trajectory of interest rates, and many investors still fear a recession. With this in mind, many investors are wary of taking on too much risk.
If there is a recession, investors are better positioned by staying investment-grade and keeping high yield exposure low. If a recession hits, the companies issuing high yield bonds are typically among the first to go.
There are points on the yield curve where investors can manage risk but also lock in a nice yield. In the current environment, investors can find investment-grade ETFs that offer an attractive yield around 6% with just two to three years of duration risk.
ETFs That Provide Exposure
Some of the largest investment-grade bond ETFs include the Vanguard Intermediate-Term Corporate Bond ETF (VCIT ), with $40 billion in assets; the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD ), with $37 billion; and the Vanguard Short-Term Corporate Bond ETF (VCSH ), with $35 billion.
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