Investment Grade Fund
a type of bond fund that comes with low credit risk compared to other funds
Investment Grade Fund Details
Three major credit rating agencies determine bond fund ratings. These credit-rating agencies are:
- Standard and Poor's
These agencies designate a minimum bond rank to qualify bond funds as investment-grade. When a company has bonds that are investment-grade, it means that its credit is in good standing. Standard & Poor's and Fitch use BBB. Moody's uses Baa3. Any rating that is below BBB is not an investment-grade bond.
Investment-grade bond funds historically have a lower default rate compared to their non-investment-grade counterparts. This is why institutional investors are inclined to invest strictly in investment-grade bonds to keep their risks at controllable levels.
Investment Grade Fund Example
A very cautious investor, Mr. Barnes is currently looking for a profitable floating rate fund to invest in. His key requirement is that more than half of the bonds in the fund should be investment-grade. The fund follows the S&P credit rating system, where 20% is rated AAA, 12% is AA, 21% is A, 9% is BBB, 35% is BB, and 3% is B.
Mr. Barnes' analyzes the information to see if the floating rate fund meets his own requirement of more than 50% of the floating rate fund being investment-grade. By S&P's system, bonds rated BBB- or higher are investment-grade. Mr. Barnes easily concludes that the fund is investment-grade, considering that more than 62% of it is invested in investment-grade bonds.
Investment Grade Fund Significance
Understanding credit ratings is very important in determining the credit risk associated with a bond. After all, credit rating has a large bearing on a bond's chances of defaulting.
In particular, investors must be conscious of an agency downgrade or a downward debt reclassification from investment grade to "junk." While this is a quick, single-stop drop, the impact can be extreme. It announces that a company is buried in debt and may not be able to pay them off. Such a downgrade can also make it harder for the company to secure financing, pushing them lower and lower as their capital costs increase.
A good understanding of investment-grade bond funds is, therefore, not only important but crucial in maintaining the integrity of such funds. It helps investors make sound decisions that can make the difference between keeping the funds investment-grade and pushing them to a downward spiral.
Difference Between Investment Grade and High Yield
While they may sound similar, investment-grade and high-yield are terms belonging to opposite poles in the world of bond ratings. Investment-grade funds offer safety with moderate returns, while high-yield funds may gain bigger returns at the expense of greater risk.
Also, investment-grade fund issuers are usually government agencies and corporations, while corporations typically issue high-yield bonds. In any case, high-yield investors have a greater tendency to default than investment-grade bond issuers.
One advantage of high-yield bonds is the stability of their markets compared to equity markets while staying as profitable. On the other hand, investment-grade bond issuers get the option to shield their investments from stock correlation.