The high yield and floating rate loan market are often misunderstood asset classes. Just what is the formal definition of “high yield”? High yield, or its more polite acronym, non-investment grade, is based off of the ratings grids provided by the two major credit rating agencies, Moody’s and Standard & Poor’s. All bonds rated below Baa by Moody’s are considered high yield or non-investment grade.
Similarly, all ratings below BBB by Standard & Poor’s are considered high yield. We remain perplexed as to how these two private companies came to monopolize the business and have become the definitive standard on who gets credit and on what terms.
Ironically, even after their well-publicized gaffes in the scandals of Worldcom and Enron, and more recently with the ratings of structured products, they ended up with more power.
Various attempts have been made to move away from traditional credit ratings, most recently with the G20 countries committing to come up with plans to reduce reliance on credit ratings by mid-2015; yet so far nothing has been successful and given that these ratings are so ingrained in the system, we remain skeptical that the fixed income market ever will ever be defined by anything other than ratings.
Investors should understand what the ratings agencies themselves say about their ratings. Among their various disclosures, the ratings agencies caution that their ratings are opinions and are not to be relied upon alone to make an investment decision, do not forecast future market price movements, and are not recommendations to buy, sell, or hold a security.