An ideal mix with high credit quality bonds
The Sterling Report
WEEK after week we've educated our readers on market activities, terminologies used and opportunities that exist in the investment arena. As investors we are now more informed about the investment options available and the selection of different assets for our portfolio has become a bit easier. Our focus this week is on safe bonds of high credit quality and the benefits of including them in our investment basket.
What is credit quality and why does it matter?
It's easy to think of a credit rating like a grade in school. The higher the grade, the better the performance of the student. Similarly with other forms of investments, the higher the credit rating of the issuer of a bond, the better the performance and the safer the issuer. Credit quality, can most easily be described as a measure of the risk of default i.e. the probability that the issuer of the bond won't repay the bondholder. High credit quality implies a low risk of default and low credit quality implies a high risk of default. Credit quality is usually assessed by well known credit rating agencies such as Standard & Poor's, Moody's and Fitch. These credit rating agencies perform detailed and thorough analyses of the economic, competitive and financial characteristics of an issuer. They then assign a rating based on the results of their analysis. These credit ratings have come to be used as a guide for assessing the safety of an investment. Each agency uses a similar scale but names the category differently but invariably the ratings are the same. Credit ratings of BBB+ or higher (the maximum being AAA) are termed "investment grade", and are assigned to companies or governments with very sound and safe financial and competitive positions. Credit ratings between BBB and C are called "junk" bonds or "below investment grade bonds" and are less safe than investment grade bonds.
Investors who value safety, should consider investing primarily in investment grade bonds. These bonds have relatively low levels of credit risk (i.e. the risk of default by the issuer and the ultimate loss of your investment). These bonds have also become very attractive with the decline in the global interest rates. The lower interest rates mean that we can earn similar returns on safer bonds with high credit ratings than we earn on more risky bonds with lower
Investment grade bonds are for everyone
Bonds of a high credit quality are always a worthy option for a well-established investment portfolio. These bonds are for clients who want to earn returns at a steady pace and don't want to worry about the safety of their investment.
For active traders, the opportunity for capital appreciation heightens the attractiveness of investment grade bonds. There are a number of high credit quality bonds available in the market that have outperformed
This illustration displays the great rewards that can be gained by actively buying and selling high credit quality bonds.
Over the years rating agencies have gained acceptance as a widely used and convenient tool for assessing the credit quality of the various bond issuers. While the ratings indeed provide guidance as to which instrument to invest in, other variables should be used in conjunction with those findings before making an investment decision. Weight should also be given to knowing the company that you are investing in and its longevity and past performance.
Dian Blackwood is Assistant vice president - Personal Financial Planning at Sterling Asset Management. Sterling provides medium to
long-term financial advice and investments in US and other world market currencies to the corporate, individual and institutional investor. Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: email@example.com. You may visit us on Facebook or follow us on Twitter and for more information please visit
our website www.sterling.com.jm