Author: Luke Isaac
The ratings for investment grade (IG) bonds range from AAA to BBB, with credit mandates often imposing restrictions on the credit quality of the mandate. Among these, BBB-rated bonds, the lowest tier of IG credit, unlock a significant portion of the IG opportunity set. For investors aiming to optimise their portfolios, understanding the nuances of BBB exposure is crucial.
Credit ratings are assigned by credit rating agencies like Moody's, S&P, and Fitch, and each provider utilises a marginally different scale. BBB-rated bonds (or Baa under Moody's) are rated as such because they are perceived to be more vulnerable to adverse economic conditions relative to their higher-rated peers (AAA, AA, A). Given their perceived greater risk of default, BBB bonds typically offer higher yields to compensate investors for this increased risk. However, as BBB bonds are still investment-grade rated, their credit risk remains lower compared to sub-investment-grade credit. This, in turn, means that BBB bonds can be particularly appealing to investors seeking higher returns while still maintaining a degree of credit quality.
Given the pivotal role that BBB-rated bonds play in the IG bond market, understanding their dynamics is essential for making informed decisions and effectively managing portfolios in varying market conditions. In this article, we will delve deeper into these dynamics, focusing on the key factors to consider when determining the appropriate level of BBB exposure in your IG credit mandate.
How have BBB bonds evolved?
As shown by the below graph, the investment-grade universe has shifted toward BBB-rated securities over the past 20 years.
Source: ICE Index. Benchmark: ICE BofA Global Corporate Index. Data as of 31 December 2025.
This has been propelled by a rise in debt issuance and further encouraged by historically low interest rates, and readily available financing. For example, in January 2005, BBB-rated bonds made up c.30% of the Global IG market value, and by December 2025, this had increased to c.45%. The trend of the investment-grade credit universe shifting towards BBB-rated securities is largely consistent across the US, Europe, and the UK, as well as across different maturities. However, regional discrepancies do exist.
Regional discrepancies
The US IG credit universe has historically contained a larger proportion of BBB-rated bonds. While it's challenging to pinpoint a single reason for this divergence, it's noteworthy that the US market benefits from a broader and more diverse sector composition compared to Europe and the UK. This diversification is reflective of the increased openness, flexibility and deep liquidity of US capital markets, which enable smaller or riskier companies to raise capital more easily. Consequently, there is a higher prevalence of sectors such as technology, healthcare and consumer goods, which are more likely to issue BBB-rated bonds.
Additionally, investor sentiment and market conditions continue to also play a significant role. Given the evolution in the IG credit universe, the role of BBB bonds in an IG credit mandate has become increasingly significant. Any restrictions on BBB exposure could substantially reduce the size of the investment universe available, potentially harming portfolio diversification and return potential. As we've explored above, these limitations can be further exacerbated depending on the region and maturity of the mandate.
Credit Spreads
Typically, there is an inverse correlation between credit ratings and credit spreads, as lower credit ratings generally correspond to higher spreads. This reflects the higher perceived risk, although this additional spread can offer higher value (assuming no defaults). The chart below shows global IG credit spreads, split by credit rating. Most of the time, the AAA-rated bucket of bonds sits at the bottom (tight spreads) and BBBs at the top.
This is not to say; however, that this relationship is not subject to fluctuations. As illustrated by the graph below, the relative value fluctuates across credit ratings. There have been instances where AAA bonds were trading wider than AAs, indicating that the relationship between a bond's credit rating and its perceived risk is not always linear (and reflecting that ratings assigned by agencies do not always tell the full story).
ICE Index. Option Adjusted Spread ('OAS'). Benchmark: ICE BofA Global Corporate Index. Data as of 31 December 2025.
Fallen angels
"Fallen angels" is the term given to bonds that have been downgraded from IG (typically BBB) to high yield. Instead of automatically selling downgraded bonds, managers typically allow a small tolerance for BBB bonds downgraded to high yield, avoiding automatic decisions on bonds with potential long-term prospects. This flexibility can prevent the destruction of value and provide managers with discretion on when to sell bonds, which is an advantage of an active approach (and to some extent a buy and maintain, i.e. a 'B&M') versus a passive benchmark-driven approach (which would automatically sell the fallen angel).
The next question that naturally arises is: how large should this tolerance range be? There is no one-size-fits-all solution. The optimal range will depend on several factors, including both the design of the investment-grade credit mandate as well as the prevailing market conditions.
For example, this approach is typically more conservative for B&M portfolios as the core focus of the portfolio is minimal turnover and stability, whilst also avoiding downgrades and defaults. However, that is not to say that there is no appetite amongst managers to hold BBB-rated bonds. Despite the more conservative nature of B&M portfolios, managers have previously noted that the return rate for BBB bonds often compensates for the risk. This could be attributed to the fact that, despite being the "riskiest" rating among Investment Grade Credit, default rates for BBB bonds have historically been relatively low and manageable.
Below is a table summarising these views of a few B&M portfolio managers we spoke to in further detail:
| What is the allocation to BBB-rated bonds in your standard B&M approach? | Do you believe that BBB return compensates for the risk in B&M? | Useful insights | |
| Manager A | c.50% - Average credit quality of A | Yes | We believe eliminating 40-50% of the investment universe creates insufficient issuer and sector diversification. |
| Manager B | Max 50% - average credit rating of A-/BBB+ | Yes | We do believe that diversified investors are compensated for the additional default risk associated with BBBs. |
| Manager C | c.43% - average credit rating of A- | Yes | A vast majority of our portfolios include BBB bonds as we believe appropriate BBBs provide diversification, yield and are risk-appropriate for most client portfolios. |
| Manager D | Client specific – aim for average credit rating of A | Yes | Risks of downgrades to BBB aren’t necessarily adequately compensated within all single-A issuers but one cannot make generalization for the entire cohort. |
| Manager E | No constraint - aim for average credit rating of A- | Yes | None of our B&M portfolios have experienced downgrades outside of the original guidelines for ratings of A- and above, or a portfolio that can go down to BBB-. |
Conclusion
BBB exposure in IG credit mandates offers a balance between higher yields and manageable credit risk; however, monitoring economic conditions and credit ratings is crucial for effective risk management. We believe skilled managers can leverage the opportunities presented by BBB bonds, including regional variations and fallen angels, to achieve a well-balanced portfolio.
Understanding the dynamics of BBB ratings, the increased issuance of BBB-rated bonds within the IG credit universe, regional distribution, default rates, and credit curve is essential for optimising portfolios. By analysing these factors, investors can enhance returns while maintaining credit quality. We note that the answer will vary depending on the specific circumstances of the investor and the role the IG credit portfolio is expected to play within the broader investment strategy.
If you would like to know whether or not you are taking too much or too little risk in this area given your current objectives, please do get in touch, and we'd be happy to help.
