What an Extra 1% Yield on Investment Grade Bonds?

March 1st, 2012 by

Jim Cramer, the host of CNBC’s mega-hit show Mad Money has said that 60% of a stock’s performance is related to its industry. If home builders are doing poorly, most home building stocks will be doing poorly as well. No matter how good a company’s management team or individual characteristics, much of a company’s performance will be determined by factors out of its control. Home builders don’t control the overall economy, prices on the real-estate market, or the availability of credit for mortgages.

For bonds, a company’s industry will play a major role in determining a the credit rating for its bonds. Bonds in declining industries (like newspapers) or where there is lots earnings volatility (oil drillers) will have lower credit ratings than other industries. Furthermore, two bonds with the same ratings but in different industries may have very different yields.

You will receive more yield when investing in the bonds of financial services companies (such as Bank of America) and less when you invest in companies provide consumer goods (such as Proctor and Gamble).

Below is chart of industry average yields for investment grade US corporate  bonds. All bonds a minimum rating of BBB.

Industry Yield To Worst 1 Year Ago Avg. Maturity Yrs
All Industries 3.31% 4.05% 9.96
Finance 3.72% 3.96% 7.60
Consumer Goods 2.62% 3.69% 9.21

Conclusions:

  • Bonds of consumer companies yield 1.10% less than financial services companies. This number would even be higher if we compensated for the Financial  bonds having shorter maturities.
  • Last year, the yields of all investment grade bonds were near 4.0%. However,  most bonds, and particularly bonds of consumer goods companies, have benefited from the economic recovery during the last year, while bonds of financial companies have not.

Why might bonds of financial companies  not have recovered?

  • Many large financial companies have exposure (risk) related to European divisions and banks. They may be penalize for the potential of an escalation of the European financial crisis.
  • Many financial companies actively borrow in the short-term credit markets to meet their daily obligations and are therefore far more sensitive to gyrations  in the market.  Even if there business is healthy, if the market gets spooked, the consequences could be very bad for their business.

For a look at some potential investments which take advantage of this thesis see our post “Are Bank Bonds Cheap?” here.

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