Find Good Yields With Triple-B Bonds
The roster of companies with a triple-B bond rating, the lowest that’s considered investment-grade, has its share of weaklings, including Best Buy, Nokia and Sony. Some of those outfits will surely get busted to junk-bond status. But the triple-B category also includes solid and improving businesses, such as Exelon, Harley-Davidson, Priceline.com and Yum Brands. Fitch Ratings, one of the three main bond graders, recently promoted Ford Motor bonds from junk to triple-B status.
The triple-B universe, which accounts for 38% of all U.S. corporate bonds, reaches from Baa1 (best) to Baa3 at Moody’s, and from BBB+ to BBB- at Fitch and Standard & Poor’s. It is the sweet spot in the never-ending search for good yields. Triple-B bonds are usually stable, yield about 4% nowadays, and occasionally can provide capital gains. Year-to-date, triple-B corporate bonds have returned 4.4%, the best of any taxable investment-grade category. Barclays Aggregate Bond index, which tracks the broad U.S. bond market, returned 1.7% (all returns are through May 4).
Why so many deals? There are a couple of explanations for the triple-B advantage. One is that the U.S. economy seems to be improving, which should benefit bonds with shakier credit ratings. Another is that you can normally find more bargains among triple-Bs than in other segments of the bond world. That’s mainly because investors perceive more credit risk in triple-B bonds than there actually is, says Mary Kane, head of taxable bonds at GW&K Investment Management, in Boston. Kane says some bond buyers, including pros who should know better, confuse a triple-B grade assigned to corporate bonds—a good rating—with the same grade given to municipal and foreign-government bonds, which is seen as a reprimand. Nations with triple-B debt, such as Ireland and Spain, are scrambling to stay solvent as their borrowing costs soar.
But most triple-B-rated firms, including regional banks, manufacturers and utilities, are in good shape. Sure, a triple-B bond in your portfolio will take a hit of 3% to 10% on its price if it gets downgraded to junk status. But in the main, triple-B is a good place to invest. A separately managed account holding mostly triple-B-rated bonds that Kane runs at GW&K has returned an annualized 8.5% over the past five years and 7.3% over the past ten. Both figures are way ahead of the Barclays Aggregate index.
Triple-Bs remain reasonably priced relative to other bonds. In early May, the yield spread (or the difference in yields) between a Barclays index of medium-maturity triple-B bonds and ten-year Treasuries stood at 1.9 percentage points. That’s in the middle of the range over the past year. When the spread drops to about one percentage point, triple-B bonds are considered expensive. For now, it’s fine to buy.
If you buy your own bonds, you can find gobs of triple-Bs at Fidelity, Schwab, E-Trade and other brokers. I’d skip bonds from big banks and buy those of regional banks and industrial firms. Although Ford bonds have gained in value since the Fitch upgrade, you can still get a 5.8% yield to maturity on a noncallable issue due in 2022 while you wait for Moody’s and S&P to upgrade Ford. I also like junk-rated General Motors bonds. Look for GM, which came out of bankruptcy in July 2009, to follow Ford back to investment-grade status in 12 to 18 months.
Mutual fund buyers have wonderful choices. A nearly pure play, as the name indicates, is PIA BBB Bond (symbol PBBBX), which must keep at least 80% of its assets in triple-B bonds. The fund, which yields 3.9%, collects extra income by owning a few emerging-markets bonds. So far in 2012, PIA BBB has returned 4.3%. Other, more familiar funds with substantial holdings of triple-B bonds include Dodge & Cox Income (DODIX), Payden Core Bond (PYCBX) and T. Rowe Price Corporate Income (PRPIX). All yield more than 3%.
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