How To Differentiate Investment & Junk Bonds

INVInvestment-grade bonds are securities sold by companies with the safest balance sheets and given relatively good ratings from the credit rating agencies.

High-yield bonds are sold by more indebted companies with more fragile balance sheets and given non investment-grade, or junk, ratings from the credit rating agencies.

There used to be a big difference in the way investors approached the two types of assets.

High-yield bonds could be attractive, for instance, but only if they came with a hefty return, or spread, to compensate investors for taking the added risk of lending money to a junk-rated company. Hence the name high-yield.?

How times have changed. This month’s sudden sell-off in U.S. investment-grade corporate debt means the difference between the “spread” earned by investing in investment-grade and the returns on offer from investing in junk-rated bonds has dropped dramatically. The below chart, from Jason Shoup, a top credit strategist at Citigroup, showing the option adjusted spread ratio between investment-grade and junk-rated bonds.

The ratio has compressed to its lowest level since 2008, suggesting investors are becoming less discriminating when it comes to differentiating between investment- and high-yield debt.

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