investing

The Rising Risk in Corporate Bonds

The BBB-rated debt tier is increasingly populated by iconic but risky outfits you might not want to finance now.

Famished and desperate bond bears, starved for what they consider an overdue feast and riled by yet another rally in long-term Treasuries, have lately sniffed out an unfamiliar target: U.S. corporate bonds. Bond-return tables confirm a dismal year for investment-grade corporate debt. The slice of the market rated BBB by Standard & Poor’s, which I’ve often said stands for “buy, buy, buy” because of its wonderful long-term record, trailed junk, municipal and government bond returns in 2018, with a total loss of about 3% through December 7. Only dollar-denominated emerging-markets bonds did worse.

That’s not a life-changing loss. And you can attribute a chunk of it to the fact that at the end of 2017, U.S. corporate bonds were expensive relative to Treasuries. What happened is that the spread, or gap, between the yields on BBB bonds and 10-year Treasuries got unusually tight a year ago and has now widened, with corporate yields rising and prices, which move in the opposite direction, falling. That repricing of debt is the primary reason for 2018’s fizzle.

Poor returns last year were “really a function of bond math,” says State Street Global Advisors’ deputy chief investment officer Lori Heinel, who sees value again in investment-grade bonds. She forecasts “mid-single-digit returns” for 2019, which suggests a 4% to 5% yield (at current bond prices), with investors breaking even or gaining just a bit on principal. I’m a little less bullish, but BBB bonds have moved into the green again in recent weeks, so the worst may be over.

The bear case. The BBB bears do make some good points, however. There has been a massive increase in corporate bond issuance since the last recession. That in itself isn’t too worrisome because the bulk of those borrowers have loads of cash. But bonds rated BBB, the lowest quality considered better than junk, account for half of all investment-grade debt by dollar volume, a proportion that has grown nonstop from 10% in the 1980s. The market shares of AA and AAA bonds have shrunk accordingly; single-A bonds have held steady at about 35%.

Moreover, the BBB layer is increasingly populated by iconic but risky outfits you might not want to finance now. General Electric’s future is murky. General Motors can still sell trucks and SUVs but has a huge and idle fixed investment in cars. AT&T is America’s biggest corporate debtor. Pacific Gas & Electric could stumble if it is found liable for causing recent California wildfires and neither the courts nor the state legislature help it compensate victims. And CVS tripled its long-term debt, borrowing $40 billion to buy Aetna last year to experiment with the marriage of a health insurance company and a string of pharmacy convenience stores.

I’m not saying—and neither is Moody’s nor S&P—that any of these bonds are on the verge of being busted to junk. But that’s possible if the economy weakens. And when BBB debt gets downgraded, pension funds and mutual funds are forced to jettison the bonds, causing their market value to drop at a rate that could easily exceed 2018’s 3% loss.

Consequently, some fund managers, investment firms and familiar market commentators are chary about parts of the BBB universe. This supports my advice to avoid total bond market mutual funds and exchange-traded funds and consider actively managed bond funds that aren’t restricted to tracking or mimicking an index. These are often called multisector, strategic or nontraditional bond funds. Next month, I’ll detail my favorites.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
How to Calculate the Break-Even Age for Taking Social Security
social security

How to Calculate the Break-Even Age for Taking Social Security

When it comes to maximizing your Social Security benefits, there are many elements to consider. One factor that can be especially enlightening is your…
August 30, 2021
Spend Without Worry in Retirement
Financial Planning

Spend Without Worry in Retirement

Fears of running out of money prevent many retirees from tapping the nest egg they’ve worked a lifetime to save. With these strategies, you can genera…
August 30, 2021

Recommended

Is a Target Date Fund Right for You?
investing

Is a Target Date Fund Right for You?

You're busy, and poring over investments is a pain. Wouldn't a target date fund be easier? Take a look at their pros and cons to see if incorporating …
September 14, 2021
25 Top Stock Picks That Billionaires Love
stocks

25 Top Stock Picks That Billionaires Love

Billionaire investors were busy during the second quarter of 2021. Here are 25 companies, of various shapes and sizes, that were some of their most re…
September 9, 2021
Is the Stock Market Closed on Labor Day?
Markets

Is the Stock Market Closed on Labor Day?

Stock markets and bond markets alike will enjoy their annual three-day weekend as America observes Labor Day.
September 5, 2021
10 Terrific Retirement Funds That Tackle Every Need
mutual funds

10 Terrific Retirement Funds That Tackle Every Need

Retirees and those nearing the end of their careers must consider growth, income and safety for their investments. Here are 10 mutual funds and ETFs t…
September 3, 2021