Once investors migrate below investment grade, there is a further bi-furcation in high yield, as many players pitch what we like to call the “cream of the crap” story. In essence, they will buy only BB rated securities. Again, an investment process that is being dictated by rating agency black boxes. We would argue that a portfolio of BB securities today could quite possibly be the worst of both worlds: you are still exposed to credit risk yet generate minimal yield. Additionally, many BB securities trade like investment grade, meaning they are often very sensitive to changes in interest rates and may have much longer durations given their lower yields.
No diatribe on ratings would be complete without a little chat about investment grade corporate bond markets. Investment grade is defined by Standard and Poor’s as BBB- and higher, while Moody’s defines it as Baa3 and higher. I have been in the leveraged finance business for 30 years. I cannot tell you the fundamental difference between a BB+ credit and a BBB- credit, yet one is “investment grade” and one is “junk.” Who gave these firms the right to determine this and how is it determined?
What this all means is that we see continued pricing inefficiencies in single B and CCC credits as most investors avoid them given their perceived “risk.”
This article was written by Tim Gramatovich, CFA, CIO for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD).