Updated July 17, 2023
Definition of Investment Grade
Investment grade is the rating given to bonds and other fixed-income securities by credit rating agencies that depict the low probability or risk of default on those securities. It helps investors make informed investment decisions based on the quality of credit rating associated with a particular bond and other investment alternatives.
Explanation
Credit rating agencies assign Different grades with uppercase letters like “A” and “B” to bonds and other fixed-interest securities. For example, bonds with credit ratings of “AAA” and “A.A.” consider high credit quality bonds, and “A” and “BBB” consider medium credit quality bonds. Below the “BBB” rating, bonds consider as low credit quality or commonly referred to as junk bonds.
This rating assigned to different bonds and securities is based on the companies’ past credit history, financial strength, level of debts, profitability potential, etc. The ratings can also change based on the change in these measuring parameters of the company. These grades help investors compare their investment options before making investment decisions.
Example
Let us take an imaginary situation where an investor wants to invest in a particular fund made up majorly of the mix of several company bonds. The one condition that an investor wants to look for while investing is that more than 60% of the fund’s bonds should be investment-grade (i.e., rating “BBB” and above). The credit allocation of the fund is as below:
| Bond ratings | Allocation |
| AAA | 25% |
| A.A. | 15% |
| A | 15% |
| BBB | 12% |
| B.B. | 30% |
| B | 3% |
| Total | 100% |
Now if we find the total percentage of funds allocated to investment-grade bonds, it is less than 60% (i.e., only 55%). Therefore, the investor’s condition is not satisfied; thus, it would not be beneficial for the investor to proceed with this investment option.
Investment Grade Rating
Credit rating agencies like Standards and Poor, Moody’s, and Fitch assign this as ratings to bonds and fixed-income securities. These are those with good credit quality ratings assigned by these agencies. Some of the ratings are below:
- AAA/ AAa: This is the highest credit quality rating assigned to bonds and other fixed-interest securities and signifies the lowest level of credit risk, i.e., with the lowest probability of default.
- A.A., A: This rating is assigned to the bonds with very low or low credit risk but a higher level of risk in comparison to the “AAA” category bonds.
- BBB/ Baa(Moody’s): The bonds with this credit rating consider to have medium credit quality risk. The bonds below the credit risk rating of “BBB” consider junk bonds. They generally offer higher yields, but the risk associated with them is comparatively high.
Investment Grade Chart
The chart used by different types of credit rating agencies for investment-grade and non-investment-grade bonds and other fixed-interest securities is as follows:
Investment-grade chart as per standards and Poor
| Rating | Description |
| AAA | The lowest level of credit risk |
| AA+, A.A., A.A.- | Very low credit risk |
| A+, A, A- | Low credit risk |
| BBB+, BBB, BBB- | Moderate credit risk |
Similarly, other credit rating agencies, like Moody’s Corporation, Fitch, etc., denote bonds and other fixed-income securities in grade ratings. These rates can be investment and non-investment, and we have seen above how Standards and Poor distinguish investment-grade deposits.
Investment Grade Issuance
Investment-grade issuance means the company’s investment-grade bonds, i.e., bonds, bills, and notes, with a high, very low, and medium credit quality risk rating (“BBB” and above).
As per Bloomberg, the U.S. corporate investment-grade issuance reached a record of $1.34 trillion in August 2020 just in eight months, surpassing the 2017 full-year sale after the Federal Bank intervention to improve liquidity in the market. This happened after the coronavirus pandemic hit the market badly. This issuance is expected to reach $2 trillion by the end of the year.
Advantages
The advantages are as follows:
- It helps investors make informed investment decisions based on the bonds’ ratings.
- It helps to compare different types of bonds and fixed-income investment options easily.
- For companies issuing bonds, it helps represent their financial strength and creditworthiness in the market.
- Since investment-grade bonds are at low risk of default, investors do not generally lose money.
Disadvantages
The disadvantages are as follows:
- Though it is rare nowadays, sometimes a false credit rating can be assigned to a high-risk bond; it can be possible when the company is projecting a wrong cash flow financial position (in the 2007-2008 recession). So, it is important to conduct your research before investing.
- This can also go down, which can happen due to a sudden event and leave an impact for a long time.
- Sometimes it becomes difficult to find a ready buyer for investment-grade bonds when the investor needs liquidity.
Conclusion
Investment-grade bonds, bills, and notes are generally preferred by low-risk investors who want to have a low but stable or fixed income. Investors looking for diversification of their portfolio also go for investment-grade bonds. These bonds offer a very low degree of risk of default and thus low return. Investors looking to invest in these bonds should consider all the associated terms and conditions, like maturity date, payment terms, interest rate calculation, etc. They should also conduct in-depth research on the company’s financial standing and creditworthiness.
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