“It’s actually pretty smart that they have issued a lot of long-term debt at very low interest rates,” Mr. Pierson said. “I am not saying they are completely insulated from rising interest rates, but it has been good financial management.”
The other noteworthy shift in investment-grade corporate bonds is a deterioration in overall quality. In 2007, 27 percent of the total value of bonds issued by companies in the Standard & Poor’s 500-stock index were rated BBB, the lowest rung of investment grade. Today, 50 percent of the market value of S.&P. 500 bonds have that rating.
Mariarosa Verde, senior credit officer at the bond-rating firm Moody’s Investors Services, said the ratings slide is, for the most part, a result of corporate intent. Companies that once had sterling ratings are “strategically deciding to take on more leverage,” she said, perhaps to finance a merger or acquisition.
Bayer, CVS, General Mills and AT&T are among the deal makers whose investment-grade bond ratings have fallen as they have borrowed more.
When bonds are downgraded because of purposeful corporate borrowing, it “can be a good time to invest,” Ms. Emery said, assuming a company has the will and the cash flow to repay that debt and crawl back up the rating ladder. That value-seeking approach helped Dodge & Cox Income to earn a 4.9 percent annualized return over the last 10 years. That was one percentage point ahead of the benchmark aggregate index.
Nonetheless, the bulge of BBB bonds could be a recipe for more volatility at the next downturn. According to Moody’s, in a recession year, 10 percent of investment-grade bonds at that lowest investment-grade tier become fallen angels, the industry term for bonds downgraded to junk status. “In the next recession, there will be more investment-grade companies at risk of becoming fallen angels than at any other time in the past,” Ms. Verde said.
That could hit index funds hardest. Once a bond is booted from investment grade down to high yield, high-grade indexes — and the funds that track them — are typically required to dispose of the bond promptly, forcing funds to sell when prices have fallen. Actively managed funds are not typically bound by such a strict sell rule.