While BB-rated bonds are classified as high yield, their default rates are nearly as low as BBBs, yet they can offer a meaningful yield premium. When considering interest-rate sensitivity, volatility and market technicals, BB bonds may present a compelling opportunity for investors seeking higher returns without excessive risk.
Reframing Risk: What are Credit Ratings?
A credit rating on a bond reflects the agency’s “opinion about an entity’s ability and willingness to meet its financial obligations in full and on time.”1 This is more commonly known as default risk. A corporate bond with a higher credit rating has a lower probability of default than one with a lower rating, according to that agency. Importantly, this does not give any indication of how “good” an investment is, nor does it provide insight into other types of risks. It is simply the agency’s assessment of default probability. Credit ratings are an important determinant of the merits of an investment but should not be the sole determinant.
Risk vs. Reward: The Case for BBs
Default risk is likely one of the first considerations that come to mind when deciding whether or not to move from investment grade to high yield. By definition, BBB-rated bonds, which are investment grade, have less default risk than BB-rated bonds, which are in the high-yield universe. BBB-rated corporate bonds have a default rate approaching zero — there have been rare defaults (years between), but most 12-month periods used in rate calculations have none. Even though they are high yield, the default rate of BBs has been zero since 2020, and in that year, it was a miniscule four bps, (0.04%). The 23-year average default rate for BB-rated bonds is just 0.36% (compared with 2.49% for the high-yield market).2 All of this to say, the increased default risk based upon observable history from moving from BBB-rated corporate bonds to BB-rated bonds is quite negligible. Despite this negligible difference, BBs outyield BBBs by 86 bps. This implies that BBs generate a disproportionate amount of incremental yield given their respective risk profiles.
Figure 1: BB Default Rates Negligibly Higher Than BBBs3
Source: J.P. Morgan 3/1/25. BBB default rate is not published. Past performance is no guarantee of future results, which will vary. Long-term default rate tracked over 23 years.
*BBB defaults are relatively rare and sporadic, and have a default rate of lower than 0.36% (usually around 0%); J.P. Morgan typically does not publish it.
BBs Have Less Interest Rate Risk
With such low default rates in both of these segments, an arguably more important measure of risk is interest-rate risk, as measured by duration. BB-rated bonds have a duration of 3.49 years, just over half that of BBBs, meaning that they are much less sensitive to interest-rate movements. Given these yield and duration dynamics, BB-rated bonds can absorb over twice the amount of spread widening as BBB-rated bonds and generate positive returns over the course of a year (all else equal), otherwise known as the breakeven yield.
Figure 2: BBs Have a Higher Yield and Shorter Duration Than BBBs
Source: FactSet 2/28/25. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index. BBB represented by ICE BofA US Corporate Bond Index (BBB). BB represented by ICE BofA US High Yield Bond Index (BB).
Volatility and Market Resilience: Why BBs May Be Safer Than You Think
Another way of viewing risk is through the volatility measure — and probably surprising to some is that, once again, lower-rated BBs can be characterized as having “less risk” than investment-grade BBBs, when defining risk as volatility. There are a couple reasons for this. The shorter duration of BBs limits price movement in response to changes in rates or spreads, and their higher average coupon (5.9% vs 4.7%) can act as a buffer against market volatility.
Figure 3: BBs Have Lower Volatility Across Time Periods
Source: FactSet 2/28/25. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index. BBB represented by ICE BofA US Corporate Bond Index (BBB). BB represented by ICE BofA US High Yield Bond Index (BB). Standard deviation is a statistic measuring the dispersion of a dataset relative to its mean. It is calculated as the square root of the variance.
Performance Advantage: Attractive Returns, More Resilience
Turning to returns, BBs have significantly outperformed BBBs across time periods. Even though issuers move back and forth between investment grade and high yield — known as “fallen angels” and “rising stars” — the demand for these bonds can be very different. Many institutional buyers have strict guidelines regarding how much high yield that they can hold. So even though BB-rated bonds may not actually be riskier than BBBs, there is less demand for them, which may support their relative attractiveness.
Figure 4: BBs Significantly Outperform BBBs
Source: FactSet 2/28/25. Past performance is no guarantee of future results, which will vary. It is not possible to invest directly in an index. BBB represented by ICE BofA US Corporate Bond Index (BBB). BB represented by ICE BofA US High Yield Bond Index (BB).
Regardless of the fact that BB-rated bonds are deemed to be lower quality, they may actually be more resilient than BBBs due to higher breakeven yields, higher coupons and shorter maturities. Given the respective track records of these rating categories, moving down in quality may offer attractive relative value, particularly when viewing risk more holistically and not solely based upon rating.
1. Source: S&P
2. J.P. Morgan
3. Default rate calculated using rating 12-months prior to default
Definitions
The ICE BofA U.S. Corporate Index tracks the performance of U.S. dollar-denominated, investment-grade corporate debt publicly issued in the U.S. domestic market.
The ICE BofA U.S. High Yield Index (BB) tracks the performance of U.S. dollar-denominated, below-investment-grade corporate debt publicly issued in the U.S. domestic market.
The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.
Duration measures how long it takes, in years, for an investor to be repaid the bond’s price by the bond’s total cash flows. Duration is a measure of sensitivity of a bond's or fixed-income portfolio's price to changes in interest rates.
About Risk
Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value. Index performance is for illustrative purposes only and does not represent actual performance.
Investing in below-investment-grade securities may carry a greater risk of nonpayment of interest or principal than higher-rated bonds. High-yield securities (junk bonds) have speculative characteristics and present a greater risk of loss than higher-quality debt securities. These securities can also be subject to greater price volatility.
Bonds are subject to interest-rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner.
Bond ratings are expressed as letters ranging from AAA, which is the highest grade, to C (“junk bonds”), which is the lowest grade. Different rating services use the same letter grades but use various combinations of upper- and lower-case letters to differentiate themselves. To illustrate the bond ratings and their meaning, we’ll use the Standard & Poor’s format: AAA and AA = high credit-quality investment grade; AA and BBB = medium credit-quality investment grade; BB, B, CCC, CC, C = low credit-quality (non-investment grade), or “junk bonds”; D = bonds in default for non-payment of principal and/or interest.
Disclosures
Opinions expressed herein are current opinions as of the date appearing in this material only. Investing involves risk, including possible loss of principal. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors, and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits.
This material represents an assessment of the market environment as of a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.
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