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In the bond universe, credit rating agencies are likened to medical professionals. They conduct checks to determine the health of bond issuers, and then release results of their findings, or ‘health reports’ on the issuers’ credit status. The world’s three biggest credit rating agencies, namely Moody’s Investors Service (Moody’s), S&P Global Ratings (S&P) and Fitch Ratings (Fitch), provide the majority of such services.
IG bonds are those that are given a credit rating of Baa3/BBB- or above by rating agencies. Among IG bonds, those with AAA or Aaa rating are exposed with the lowest credit risk. Meanwhile, bonds rated below Baa3/BBB- are regarded as HY2 bonds.
Bond ratings and bond yields1 are negatively correlated. As bonds with higher ratings are deemed to have relatively lower credit risks, the risk premium that investors seek would also be lower. Thus, bond issuers can offer lower bond yields at relatively lower financing costs.
IG bonds rated BBB- generally receive the most attention. As such bonds are at the lowest notch within the IG space, once issuers encounter any business difficulties or special events, their credit risk could rise and that would have an impact on the credit status. They may then be downgraded to non-IG bonds, or HY2 bonds, and become so-called “fallen angels”.
In the first quarter of 2020, the global public health crisis and the oil price collapse made a significant impact on the HY2 bond market. S&P data shows that 403 “fallen angels” were newly categorised as such this year, and more than 1203 were deemed as potential “fallen angels”, as of 31 July.
HY2 bonds are also commonly known as junk bonds, or non-IG bonds. These are bonds with credit ratings below Baa3/BBB-.
Other than a “fallen angel”, a “rising star” is another common reference in the European and US HY2 bond markets. “Rising stars” had originated in the US bond market in the 1980s. At that time, a number of start-up companies in new industries had issued HY2 bonds to raise funds, and they eventually became industry leaders. This is why “rising stars” are generally referred to as HY2 corporate bonds that could potentially be upgraded to IG as their credit quality improves.
As interest rates could stay low for longer, HY2 bonds would likely remain on the radar of investors seeking yield1.
Still, the credit status of HY2 bond issuers could vary, and the extent of default risk is also difficult to be accurately estimated. As such, robust research analysis of bond issuers is key to HY2 bond investing.
Market volatility and lower yields are here to stay. Investors, based on their investment objectives and risk appetite, could tap credit ratings as a guide as they diversify4 across different income sources for potential yield1 opportunities, and to help manage portfolio risk5.