how investment grade works
individuals and businesses are given credit ratings based on their credit histories lenders use these ratings to decide whether they will do business with and extend credit to potential borrowers similarly investments are given credit ratings that lenders and investors can use to determine whether they want to invest in them grades work just like credit scores for consumers and companies an investment grade credit rating indicates a low risk of a credit default making it an attractive investment vehicle especially for conservative investors a speculative grade on the other hand is the opposite of an investment grade this grade indicates that the investment comes with a greater degree of risk ratings are given to investments by different agencies including s p moody s and fitch how they are rated varies based on the agency for instance 2we go into more detail on these ratings and their scales below special considerationsinvestors should note that u s government bonds also known as treasuries are generally granted the highest possible credit quality rating in the case of municipal and corporate bond funds a fund company s literature such as its fund prospectus and independent investment research reports reports an average credit quality for the fund s portfolio as a whole in august 2023 fitch downgraded the credit rating for the united states moving it from a aaa rating to aa the agency cited potential issues with the country s fiscal condition over the next three years because of the political climate according to fitch fitch also stated that shocks to the economy related to tax cuts and increased government spending are raising the national debt which could be problematic for the country s ability to pay its bills 3many institutional investors have a rigid policy of limiting their bond investments solely to investment grade issues 4investment grade credit rating detailsinvestment grade issuer credit ratings are those rated at least bbb s p fitch or baa3 moody s the exact ratings depend on the credit rating agency investment grade credit ratings include companies with any credit rating in this category boast a high capacity to repay their loans however those awarded a aaa rating stand at the top of the heap and are deemed to have the highest capacity of all to repay loans the next category down includes the following ratings companies with these ratings are considered to be stable entities with robust capacities for repaying their financial commitments however such companies may encounter challenges during deteriorating economic conditions the bottom tier of investment grade credit ratings delivered by standard and poor s include companies with these ratings are widely considered to be speculative grade and are even more vulnerable to changing economic conditions than the prior group nevertheless these companies largely demonstrate the ability to meet their debt payment obligations 5according to moody s investment grade bonds comprise the following credit ratings the highest rated aaa bonds possess the least credit risk of a company s potential failure to repay loans by contrast the mid tier baa rated companies may still have speculative elements presenting high credit risk especially those companies that paid debt with expected future cash flows that failed to materialize as projected 6as noted above fitch ratings are similar to those issued by s p investment grade ratings are as follows 7downgrading from investment gradeinvestors should be aware that an agency downgrade of a company s bonds from bbb to bb reclassifies its debt from investment grade to junk status although this is merely a one step drop in credit rating the repercussions can be severe the drop to junk status telegraphs that a company may struggle to pay its debts the downgraded status can make it even more difficult for companies to source financing options causing a downward spiral as costs of capital increase 8