Cash Investors are Taking a Second Look at BBB Bonds
Amid expectations that the Fed will soon complete its about-face from hawk to dove with its first rate cut since 2008, cash investors are looking as hard as ever for relatively safe short-term investments capable of delivering decent returns. And many are turning to a market that in the past they often overlooked—corporates with BBB ratings.
Why are institutional cash investors starting to consider lower-rated corporate bonds that may not have made the cut in the past? Even if that may require a rewrite of portfolio investment policies? It’s not just a matter of higher returns, although the upside can be significant. Equally important are factors such as recent reductions in the supply of higher-rated corporate cash investment vehicles, the huge growth of the market for BBB debt, and the very low default risk associated with carefully chosen BBB corporate bonds.
Our July research report—Do BBB Corporate Bonds Belong in Treasury Management Portfolios?—explains why corporate cash managers might want to give them a second look. We first reported on this interesting market back in 2015, in the midst of falling credit ratings and upheaval caused by money market fund reforms. At the time, we said that with good research and a focus on corporate issuers (versus more volatile financial issuers), a portfolio with an appropriate portion of BBB debt could potentially deliver substantially higher returns while maintaining acceptable levels of risk.
In the years since, the BBB market has only gotten more worthy of notice. There has been constant growth in supply, and default rates have averaged well below one percent for corporate BBB bonds with a one-year duration.
But our report also advises that you look before you leap. More important, we tell you where to look. BBB bonds are less liquid than Treasuries, and ongoing credit research is an absolute must. But if you start with a conservatively constructed portfolio that has a core of high-quality liquid investments, BBB debt can be layered in as an attractive risk diversifier and yield enhancer.
So, if you are searching for acceptable yield as supply challenges intensify in the short-duration debt market—especially in a period of potentially lower interest rates—take a look at corporates with a BBB rating. It may fall short of a traditional Tier-1 investment grade, but with careful management it may compensate you for the moderately higher credit and liquidity risk it represents.