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As the drumbeat of concern about the risks lurking in the corporate bond market grows, Tom
Murphy and Tim Duvek are unfazed. The veteran managers of a bond fund at Columbia
Threadneedle have loaded up on triple B debt, the riskiest corner of the investment-grade universe
and one whose rapid growth has prompted warnings from the International Monetary Fund and
rating agencies. The value of triple B bonds in the Bloomberg Barclays index, a widely followed
benchmark for corporate debt buyers, has grown from $670bn at the end of 2008 to $2.5tn at the
end of 2017. Citigroup and AT&T are among the borrowers rated triple B, which now accounts for 49
per cent of investment-grade debt, up from a third in 2008 and just 25 per cent in 2000. After a
decade in which quantitative easing has encouraged fixed-income investors to take greater risk in
the hunt for returns, the increasingly urgent question is how triple B debt will fare as interest rates
rise and, ultimately, when the next economic downturn arrives. “Not to be disparaging but I care
more about what our risk analysts think about a company than what S&P and Moody’s think,” Mr
Murphy said. Triple B bonds now account for almost 80 per cent of the fund he co-manages with Mr
Duvek. But as with other investment-grade debt managers who are betting big on triple B, the stakes
are high for the Columbia duo. The category of triple B sits just one downgrade away from high-
yield, or junk, bonds — the poorer but richer-yielding relative that investment-grade funds are not
allowed to own much of. Given triple B debt now makes up a big slice of the major indices investors
benchmark their performance against, the fear is that a tougher economic backdrop triggers a wave
of downgrades that unleashes forced selling. “For us, it is raising a lot of concern,” said Margaret
Steinbach, a fixed-income specialist at the asset manager Capital Group. “In the next downturn, I
don’t know if investors are positioned correctly because they are taking a lot of risk.” It is a danger
magnified for those fund managers who have chosen to go overweight in the riskier end of
investment-grade debt. They include the asset manager Lord Abbett, where triple B debt accounts
for 73 per cent of its corporate bond fund. BNY Mellon has a fund at just over 63 per cent while the
investment firm Delaware’s corporate bond fund stands at 62 per cent. Michael Wildstein, who
manages the Delaware portfolio, agreed that a series of triple B borrowers will be banished to the
junk bond universe. However, “the securities we are purchasing for that triple B bucket are names
we believe will hold up through the cycle”, he said. “We find credits in defensive sectors like banking
or utilities where the leverage targets are achievable.” Investors who are bullish on the less
salubrious end of investment-grade debt are quick to point out that not all triple B debt is created
equal. Echoing Mr Wildstein, the fund managers at Columbia like owning bonds issued by utilities
companies as it is a more defensive sector that held up well during the last cycle while much higher-
rated mortgage bonds and bank debt tumbled. In the next downturn, I don’t know if investors are
positioned correctly because they are taking a lot of risk “It’s not like we understood what happened
better than other people but the fact of the matter is Lehman Brothers was single A on a Friday
afternoon and bankrupt on Monday and I don’t see how that could happen to the utilities we own,”
Mr Murphy said. What is more, within the triple B bucket there are subtle differences. At S&P
Global, for example, its ratings range from triple B plus to triple B minus while at Moody’s they span
Baa1 to Baa3. Columbia’s triple B allocation is 46 per cent in Baa1, which the bond fund argues
makes it closer to being A rated than junk. The fund also is not using any of its permitted allocation
to own high yield debt, giving it some cushion before it would become a forced seller due to
downgrades. The returns of the Columbia fund last year matched the Bloomberg Barclays US 1-5
year corporate index with a return of 2.56 per cent and has slightly outperformed in the first nine
months of this year with a return of 0.45 per cent. While triple B bulls bristle at people writing off
the whole category as a tinderbox waiting to blow, there is acknowledgment across most corporate
debt investors that the largest risks lie in the debt issued to finance highly leveraged mergers and
acquisitions. Steven Boothe, lead portfolio manager of the global investment grade corporate bond
strategy at T-Rowe Price, said: “People should be asking, where in triple B are the problems hidden?
They are in merger finance.”