Once the gold standard of safety, the AAA rating told investors that a company was in good health and would almost certainly not default on its bonds. But Standard & Poor’s, one of the three main ratings agencies along with Fitch and Moody’s, has steadily reduced the number of AAA-rated public companies to just six, down from 27 a decade ago. (You’ll recognize the names: Automatic Data Processing, Exxon Mobil, Johnson & Johnson, Microsoft, Pfizer and Berkshire Hathaway.) Other agencies haven’t even been that generous. Fitch and Moody’s downgraded Berkshire (ironically, Berkshire owns 20 percent of Moody’s). Pfizer, meanwhile, could get downgraded this year, according to S&P. In March, General Electric lost its AAA status, a distinction the company had held since 1956. “It’s a dying breed,” says Bob Persons, manager of the MFS Bond fund.
This rash of downgrades isn’t setting off many alarms in corporate America. In fact, analysts have even stopped looking at AAA firms as a class unto themselves, given that some don’t even issue long-term debt. Plus, as companies are under more pressure than ever to deliver strong financial results to shareholders, many firms are deciding that maybe it’s not the best strategy to “manage to the AAA rating,” says Diane Vazza, head of global fixed-income research for S&P. UPS, for example, decided early last year that shareholders would be better served if the company increased its debt to buy back shares, boosting the earnings per share but relinquishing its AAA rating.
But from the investors’ standpoint, the loss in AAA-tier firms is changing their bond strategy. With the top-tier firms nearly nonexistent, the second tier becomes the new hot spot. Cable company Comcast and retailer CVS are both BBB-plus-rated companies, for instance, with recession-resistant businesses and bonds that yield 7.8 percent and 5.8 percent, respectively. By contrast, similar AAA-rated Johnson & Johnson bonds yield 5 percent. Indeed, while defaults on the whole are expected to rise, analysts say investors who stick with BBB companies in food, cable and utilities don’t risk that much in exchange for higher yields. Another good example: Kraft Foods, which yields 6.3 percent.
Think twice about going too far down the bond chain. “Never has there been a brighter demarcation between investment grade and junk bonds,” Persons says. “Junk” and high-yield debt carry yields as high as 20 percent, since those firms have a higher risk of default. If that happens, an investor could wind up with nothing.
