Often times referred to as “high quality” or “upper tier” high yield, BB-rated bonds are a frequently overlooked asset class that offers investors attractive absolute and risk-adjusted returns. Sitting at the top of the high yield bond market rating scale, the BB market is a robust market in and of itself and now encompasses $546bn in market value across 310 issuers and 820 distinct issues. BBs currently represent approximately 43% of the $1.27trn high yield market. For comparison purposes, ten years ago, as the domestic economy was emerging from the Global Financial Crisis, the BB market was just $214bn in market value and 33% of the overall high yield market.
As shown in the chart and table below, BB-rated bonds have a long-term track record of superior absolute and risk-adjusted returns compared to BBB and single-B rated notes.
There are several key attributes that lead to the higher absolute return and Sharpe Ratio for BB bonds:
Turning to fundamentals, credit quality amongst BB-rated issuers is quite good. Net leverage continues to decline, and is below its long-term average of 4.2x . Net leverage and coverage for BBB- and single-B rated issues has also improved, but not to the extent of the improvement in BBs metrics. Revenue and EBITDA growth for the high yield market overall was +8.1% and +12.9% in the first quarter, according to JPMorgan, and the second quarter is tracking to be even better. Additionally, as discussed in a previous blog post, High Quality High Yield Set to Benefit from Tax Reform the tax reform act passed in late 2017 should help to improve the after-tax cash flows of most corporate issuers, especially BBs. In time, this will enhance the credit quality of the market as companies have less incentive to incur more leverage as the after-tax cost of debt increases.
Credit investors, in general, have enjoyed the recent span of above trend economic growth, low interest rates and benign defaults. It is difficult for investors to predict when the current expansion will turn or how quickly interest rates will rise, but BB-rated bonds have provided superior risk-adjusted returns across market cycles. Historically nominal credit losses should continue to be tempered by improving leverage metrics and the effects of accommodative tax policy will become increasingly evident in the quarters to come. These factors, combined with attractive carry and modest duration, put BBs in the sweet spot of the credit spectrum.
 Bloomberg/Barclay’s index data as of August 31, 2018
 Moody’s Investors Services calculates credit loss based on the issuer-weighted average default rate and the issuer-weighted senior unsecured bond recovery rate
 ICE Bank of America Merrill Lunch indices