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Do BBB Corporate Bonds Belong in Treasury Management Portfolios?

2 min read

Abstract

BBB and Tier 2 rated debt instruments have evolved to a much larger
presence in the short-duration corporate debt market than a decade ago.
Default experiences and rating migration data suggest moderately higher
credit risk than A-rated instruments, while expected returns also were higher.
This ratings category opens up an opportunity set not found in money
market funds. While not suitable for all treasury organizations, those that
could take advantage of the new debt class may be well compensated.
Guiding Principles:

  1. Expect lower market liquidity
  2. Steer clear of BBB financial issuers
  3. Credit research is essential
  4. Use BBB debt as part of a conservatively constructed core portfolio

Introduction

About a decade ago, we wrote a white paper comparing the risk profiles
of A and AA-rated corporate bonds as candidates for institutional cash
portfolios. We concluded that A-rated corporate bonds offer sound liquidity,
yield advantage and improved risk diversification with only negligible
incremental risk when compared to a portfolio with an AA-rated mandate.
(Original article here.)
Since then, a lot has changed in the cash investment industry landscape.
On the one hand, as the generally downward rating migration continues,
AAA and AA-rated corporate bonds are fast becoming museum collections.
On the other hand, credit intermediation dynamics in the capital markets
since the 2008 financial crisis resulted in strong issuance and acceptance
of BBB-rated (and Tier 2 short-term commercial paper) debt in recent years.
In this installment, we will take a closer look at the lower rung of the
investment grade ratings ladder and discuss the suitability and
considerations of BBB-rated corporate securities in a short-duration liquidity
portfolio.
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Lance Pan joined Capital Advisors Group in 2003. As Director of Investment Research and Strategy, Lance assesses the risk and relative value of asset classes and credits, creates advanced credit approval and surveillance procedures, issues credit opinions, and provides investment strategy recommendations. Lance oversees Capital Advisors Group’s Credit Committee.

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