Labor Day barbecues, beaches, and bonds: Why it's all about balance (Part 2 of 4)
Investment Grade Steak Just like a prime, choice, or select cut of beef, there are investment grade bonds that are rated according to credit quality. Investment grade describes bonds that are “AAA” or “AA” (high credit quality) and “A” to “BBB” (medium credit quality). As with those who love a good steak, investment grade bonds suit those who seek high quality in exchange for less risk. It may not be as lean as chicken, but it may provide a little more flavor in the form of extra yield.
Market Realist – The above graph shows the risk-to-return relationship of various bond (BND) categories by their ratings. Treasuries (TLT), which are considered free from defaults, have the lowest returns and the lowest volatility levels.
As credit quality falls, both returns and volatility rise. Treasuries (IEF) gave the lowest returns of 7.5% between 1983 and 2013, but their expected volatility was relatively low at 4.9%. Investment-grade bonds (AGG) offer higher returns than Treasuries and lower risks compared to high yield bonds (JNK). The additional return from investment-grade bonds (LQD) over U.S. Treasuries is called “credit premium.”
The iShares Core US Aggregate Bond ETF (AGG) has given year-to-date returns of 3.5%, whereas the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has given year-to-date returns of 5.64%.
Read on to the next part of this series to understand how to incorporate high yield bonds in your fixed income portfolio.
Browse this series on Market Realist: