Vanguard Corporate Bond (VCIT) quality

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Vanguard Corporate Bond (VCIT) quality

Post by NoRoboGuy »

According to it's overview, Vanguard claims its Intermediate-Term Corporate Bond ETF (VCIT) "Invests primarily in high-quality (investment-grade) corporate bonds."

But then we see the breakdown by quality is:
U.S. Government 0.7%
AAA 0.4%
AA 4.9%
A 39.0%
BBB 55.1%
NR -0.1%
Total 100.0%

How can they claim the ETF is primarily high-quality when more than 50% of the portfolio is BBB?
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Re: Vanguard Corporate Bond (VCIT) quality

Post by arcticpineapplecorp. »

even Fidelity says:
Bonds with a rating of BBB- (on the Standard & Poor's and Fitch scale) or Baa3 (on Moody's) or better are considered "investment-grade." Bonds with lower ratings are considered "speculative" and often referred to as "high-yield" or "junk" bonds.

https://www.fidelity.com/learning-cente ... nd-ratings
different agencies have different ratings:

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Re: Vanguard Corporate Bond (VCIT) quality

Post by grok87 »

NoRoboGuy wrote: Tue May 17, 2022 9:21 pm According to it's overview, Vanguard claims its Intermediate-Term Corporate Bond ETF (VCIT) "Invests primarily in high-quality (investment-grade) corporate bonds."

But then we see the breakdown by quality is:
U.S. Government 0.7%
AAA 0.4%
AA 4.9%
A 39.0%
BBB 55.1%
NR -0.1%
Total 100.0%

How can they claim the ETF is primarily high-quality when more than 50% of the portfolio is BBB?
so it's an index fund. it is tracking what the index is.

your question is a good one though. the corporate bond market did not used to be this heavily skewed toward BBB ratings. as discussed here
https://www.insightinvestment.com/unite ... nvergence/

i consider this an example of goodhart's law
https://en.wikipedia.org/wiki/Goodhart%27s_law

if all the market cares about is that issuers be investment grade (BBB and higher) then guess what everything is going to converge to BBB.

I follow swensen and basically put my bonds in treasuries and tips. has paid off this year so far.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by NoRoboGuy »

Looks like I fell into a semantic trap. So technically BBB is investment grade, but I do not personally consider BBB to be high quality. It seems disingenuous to call BBB high quality, while the next lower tier is "junk".

It reminds me of Starbucks. They do not sell any small drinks. They sell Venti, Grande and Tall.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by Elric »

Because BBB is still within the definition of "investment grade." BBB is the lowest rating that is investment grade, BB is the highest rating for a junk bond.

One source reports "Historically, investment-grade bonds witness a low default rate compared to non-investment grade bonds. For example, S&P Global reported that the highest one-year default rate for AAA, AA, A, and BBB-rated bonds (investment-grade bonds) were 0%, 0.38%, 0.39%, and 1.02%, respectively. It can be contrasted with the maximum one-year default rate for BB, B, and CCC/C-rated bonds (non-investment-grade bonds) of 4.22%, 13.84%, and 49.28%, respectively."
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Re: Vanguard Corporate Bond (VCIT) quality

Post by alex_686 »

NoRoboGuy wrote: Tue May 17, 2022 9:39 pm Looks like I fell into a semantic trap. So technically BBB is investment grade, but I do not personally consider BBB to be high quality. It seems disingenuous to call BBB high quality, while the next lower tier is "junk".

It reminds me of Starbucks. They do not sell any small drinks. They sell Venti, Grande and Tall.
So to counter, how would you set the line between investment grade and high yield? I mean, by definition there is always going to be a bond that scores 1 notch above high yield.

Besides banks, the current environment encourages either very low leverage or very high leverage. Low leverage means few bonds issued, high leverage means many bonds issued. It gets you the lowest weighted cost of capital.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by NoRoboGuy »

alex_686 wrote: Tue May 17, 2022 9:52 pm So to counter, how would you set the line between investment grade and high yield? I mean, by definition there is always going to be a bond that scores 1 notch above high yield.
Simply put, they could define four categories, not two (like high, medium, marginal, and low quality) in clear terms. You make a good point that leverage seems to be a feast or famine arrangement. Not much action in the middle.

Grok87's post linked to a good article explaining the drift down in quality. It might be more useful to investors if ratings were reclassified into something like this: AA or higher: high quality, A to BBB: medium quality, BB: marginal quality, and below BB: low quality.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by alex_686 »

NoRoboGuy wrote: Tue May 17, 2022 10:13 pm
alex_686 wrote: Tue May 17, 2022 9:52 pm So to counter, how would you set the line between investment grade and high yield? I mean, by definition there is always going to be a bond that scores 1 notch above high yield.
Simply put, they could define four categories, not two (like high, medium, marginal, and low quality) in clear terms. You make a good point that leverage seems to be a feast or famine arrangement. Not much action in the middle.

Grok87's post linked to a good article explaining the drift down in quality. It might be more useful to investors if ratings were reclassified into something like this: AA or higher: high quality, A to BBB: medium quality, BB: marginal quality, and below BB: low quality.
I am going to disagree with you. What would be the purpose of diving the 2 major categories into 4 major categories. What functional difference would you expect from bonds of high quality verse medium quality? I mean, there is no real functional difference between BBB and BB bonds. Well, I can't say no functional difference. Sometimes there is a statistical hint of a difference between the 2. Which also ties into my point. It is not like there are hard lines between credit grades. Both relative and absolute risk vary over time. Don't let the clean quantitative grades fool you - it is a fuzzy subject.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by secondopinion »

Elric wrote: Tue May 17, 2022 9:45 pm Because BBB is still within the definition of "investment grade." BBB is the lowest rating that is investment grade, BB is the highest rating for a junk bond.

One source reports "Historically, investment-grade bonds witness a low default rate compared to non-investment grade bonds. For example, S&P Global reported that the highest one-year default rate for AAA, AA, A, and BBB-rated bonds (investment-grade bonds) were 0%, 0.38%, 0.39%, and 1.02%, respectively. It can be contrasted with the maximum one-year default rate for BB, B, and CCC/C-rated bonds (non-investment-grade bonds) of 4.22%, 13.84%, and 49.28%, respectively."
However, we would want to consider the default rates cumulatively over a timeframe; usually, bond downgrade over time if they are going to default. A year’s time is normally not enough to highlight their behavior. Also, the survival rate of BB and B are not as slim as the statistics shared would suggest; but CCC usually default and anything lower is almost certain. Of course, we must not forget that bond recovery is also a thing; it does not always happen, but some recovery is the usual result.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by secondopinion »

NoRoboGuy wrote: Tue May 17, 2022 10:13 pm
alex_686 wrote: Tue May 17, 2022 9:52 pm So to counter, how would you set the line between investment grade and high yield? I mean, by definition there is always going to be a bond that scores 1 notch above high yield.
Simply put, they could define four categories, not two (like high, medium, marginal, and low quality) in clear terms. You make a good point that leverage seems to be a feast or famine arrangement. Not much action in the middle.

Grok87's post linked to a good article explaining the drift down in quality. It might be more useful to investors if ratings were reclassified into something like this: AA or higher: high quality, A to BBB: medium quality, BB: marginal quality, and below BB: low quality.
I do not exactly agree with the article. The claim that the AAA to A should be sold is kind of a bad recommendation; if they were really going to consider downgrading, then why are the yields not going up drastically?

Here is the charts from 1997 on: I will bar the discussion concerning 2008 and 2020 as anomalies (since if anything, speaks in favor of higher quality bonds). My "average" are rough estimates: I might be wrong here.
  • AA: from 1997 on, the yields have stayed at about 1% as the average spread. In 2011 (the worse peak I will consider), it was 2%. At the time the article was written, the yield was about 0.6%. 0.4% off the average and 1.4% off the high. As of the end of April 2022, it was 0.86% https://fred.stlouisfed.org/series/BAMLC0A2CAA.
  • A: from 1997 on, the yields have stayed at about 1.25% as the average spread. In 2011, it was 2.5%. At the time the article was written, the yield was about 0.8%. 0.45% off the average and 1.7% from the high. As of the end of April 2022, it was 1.17% https://fred.stlouisfed.org/series/BAMLC0A3CA
  • BBB: from 1997 on, the yields have stayed at about 2% as the average spread. In 2011, it was 3.25%. At the time the article was written, the yield was about 1.25%. 0.75% off the average and 2% from the high. As of the end of April 2022, it was about 1.71% https://fred.stlouisfed.org/series/BAMLC0A4CBBB
What was see is that tail risk is present in lower quality issues. Had we listened to their advise, we would have seen more losses since the article until now from the spread widening (maybe not by any means terribly, but it still it is kind of against what was suggested). I have not addressed 2008 and 2020 on purpose since they would make BBB look bad. Strangely, BB did not experience as much of a problem. From the article, it was about 2.6%. End of April 2022, it was 2.85%. However, the average is about 3.5% and the maximum in 2011 was 6.5-7%. The tail risk is very much real. https://fred.stlouisfed.org/series/BAMLH0A1HYBB

In short, why be against high-quality bonds? They have never been a major return vehicle, but they have not been risky. Historically by the yield spreads, A and greater have better durability.
Last edited by secondopinion on Wed May 18, 2022 1:56 pm, edited 1 time in total.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by Elric »

secondopinion wrote: Wed May 18, 2022 10:22 am However, we would want to consider the default rates cumulatively over a timeframe; usually, bond downgrade over time if they are going to default. A year’s time is normally not enough to highlight their behavior.
I know that VCIT has a small percentage of its portfolio in bonds that are below investment grade, but as a general rule, won't those bonds that are downgraded be dropped from the investment grade index VCIT follows, and therefore dropped from VCIT? If a bond trends down in ratings and eventually defaults, aren't the odds that VCIT sold it before default (granted likely for a loss in principal)?
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Re: Vanguard Corporate Bond (VCIT) quality

Post by alex_686 »

Elric wrote: Wed May 18, 2022 12:57 pm
secondopinion wrote: Wed May 18, 2022 10:22 am However, we would want to consider the default rates cumulatively over a timeframe; usually, bond downgrade over time if they are going to default. A year’s time is normally not enough to highlight their behavior.
I know that VCIT has a small percentage of its portfolio in bonds that are below investment grade, but as a general rule, won't those bonds that are downgraded be dropped from the investment grade index VCIT follows, and therefore dropped from VCIT? If a bond trends down in ratings and eventually defaults, aren't the odds that VCIT sold it before default (granted likely for a loss in principal)?
Yes, there is panic selling when a bond falls from investment grade to high yield. Lots of portfolios have to dump bonds when the cross over. And in a larger context this is a indictment on blindly following credit agency ratings and bond indexing. There is a large gap in pricing between BBB and BB bonds that can't be explained by the default rates. People make good money front running the credit agencies.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by secondopinion »

Elric wrote: Wed May 18, 2022 12:57 pm
secondopinion wrote: Wed May 18, 2022 10:22 am However, we would want to consider the default rates cumulatively over a timeframe; usually, bond downgrade over time if they are going to default. A year’s time is normally not enough to highlight their behavior.
I know that VCIT has a small percentage of its portfolio in bonds that are below investment grade, but as a general rule, won't those bonds that are downgraded be dropped from the investment grade index VCIT follows, and therefore dropped from VCIT? If a bond trends down in ratings and eventually defaults, aren't the odds that VCIT sold it before default (granted likely for a loss in principal)?
Right; that is partially my point. VCIT is going to have hardly any defaults. The yearly default rates has little to do with VCIT for the most part.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by grok87 »

secondopinion wrote: Wed May 18, 2022 11:28 am
NoRoboGuy wrote: Tue May 17, 2022 10:13 pm
alex_686 wrote: Tue May 17, 2022 9:52 pm So to counter, how would you set the line between investment grade and high yield? I mean, by definition there is always going to be a bond that scores 1 notch above high yield.
Simply put, they could define four categories, not two (like high, medium, marginal, and low quality) in clear terms. You make a good point that leverage seems to be a feast or famine arrangement. Not much action in the middle.

Grok87's post linked to a good article explaining the drift down in quality. It might be more useful to investors if ratings were reclassified into something like this: AA or higher: high quality, A to BBB: medium quality, BB: marginal quality, and below BB: low quality.
I do not exactly agree with the article.
i also do not exactly agree with the article. i posted it because it had some data on how the percentage of investment grade bonds that are BBB has increased. i think that is a bad thing. the article writers seem to think it is ok somehow.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by grabiner »

Elric wrote: Wed May 18, 2022 12:57 pm
secondopinion wrote: Wed May 18, 2022 10:22 am However, we would want to consider the default rates cumulatively over a timeframe; usually, bond downgrade over time if they are going to default. A year’s time is normally not enough to highlight their behavior.
I know that VCIT has a small percentage of its portfolio in bonds that are below investment grade, but as a general rule, won't those bonds that are downgraded be dropped from the investment grade index VCIT follows, and therefore dropped from VCIT? If a bond trends down in ratings and eventually defaults, aren't the odds that VCIT sold it before default (granted likely for a loss in principal)?
Yes, but that isn't really a benefit. If a bond has a 20% probability of defaulting and the recovery would be half its value, the bond will be worth 100% of par if it doesn't default and 50% if it does, averaging 90%. If the fund sells the bond rather than waiting to see whether it defaults, it still takes the 10% expected loss.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by secondopinion »

grok87 wrote: Wed May 18, 2022 9:53 pm
secondopinion wrote: Wed May 18, 2022 11:28 am
NoRoboGuy wrote: Tue May 17, 2022 10:13 pm
alex_686 wrote: Tue May 17, 2022 9:52 pm So to counter, how would you set the line between investment grade and high yield? I mean, by definition there is always going to be a bond that scores 1 notch above high yield.
Simply put, they could define four categories, not two (like high, medium, marginal, and low quality) in clear terms. You make a good point that leverage seems to be a feast or famine arrangement. Not much action in the middle.

Grok87's post linked to a good article explaining the drift down in quality. It might be more useful to investors if ratings were reclassified into something like this: AA or higher: high quality, A to BBB: medium quality, BB: marginal quality, and below BB: low quality.
I do not exactly agree with the article.
i also do not exactly agree with the article. i posted it because it had some data on how the percentage of investment grade bonds that are BBB has increased. i think that is a bad thing. the article writers seem to think it is ok somehow.
I can maybe agree with why the quality is degrading (over borrowing cheap debt); but as you said, this is not a good thing for the bond investor to see this.

They talk about inefficiencies to keep A and greater bond ratings? Try working for a company that is threatened with non-investment grade downgrade (they were at BBB- with negative outlook); they were scrambling to raise their ratings to the point of shutting down profitable but riskier ventures (which I was the main software developer for one of them; long story that could have had major potential for my career if it succeeded fully). No, the BBB class companies fight for ratings as well; possibly even more if they go too far.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by NoRoboGuy »

Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
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Re: Vanguard Corporate Bond (VCIT) quality

Post by secondopinion »

NoRoboGuy wrote: Thu May 19, 2022 4:58 pm Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
I am not sure. It does make it a little bit riskier, but we should hopefully have some higher returns as well. Unless one is holding a lot of corporate bonds in their portfolio (like 40%+), I do not think it will make much of a difference.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by alex_686 »

NoRoboGuy wrote: Thu May 19, 2022 4:58 pm Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
I do, but not for the reasons you may think.

Heterogeneous systems tend to be more robust than homogeneous systems. Now, in the credit markets everybody has come up with the same answer for financing their corporations. If the group think came to the wrong answer - well - this is how market bubbles and crashes happen.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by 000 »

NoRoboGuy wrote: Thu May 19, 2022 4:58 pm Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
Would the fund be required to dump them if they fall past BBB? If so, I think that is a pretty big reason to be concerned, and a potential future buying opportunity for others.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by Elric »

000 wrote: Thu May 19, 2022 5:41 pm
NoRoboGuy wrote: Thu May 19, 2022 4:58 pm Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
Would the fund be required to dump them if they fall past BBB? If so, I think that is a pretty big reason to be concerned, and a potential future buying opportunity for others.
Yes. Not instantly, but an index of investment grade bonds will drop bonds that fall below investment grade from the index (I think at the end of the month). A bond fund following that index doesn't have to instantly dump the bond, but will do so in short order, as otherwise it drifts from the index, and from being an investment quality fund.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by grok87 »

alex_686 wrote: Thu May 19, 2022 5:40 pm
NoRoboGuy wrote: Thu May 19, 2022 4:58 pm Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
I do, but not for the reasons you may think.

Heterogeneous systems tend to be more robust than homogeneous systems. Now, in the credit markets everybody has come up with the same answer for financing their corporations. If the group think came to the wrong answer - well - this is how market bubbles and crashes happen.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by NoRoboGuy »

Let's say that for some random reason <s> we just happen to get into a recession with 55% of the portfolio rated BBB. I wonder if the low risk profile (2 out of 5) assigned to VCIT is just a wee bit overstated...
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Re: Vanguard Corporate Bond (VCIT) quality

Post by averagedude »

I believe this etf is of high quality, but it does have credit risk because it is all corporate bonds. I would be comfortable with the BBB rating, but I am aware that if SHTF in the equity market, this bond fund will more than likely be more correlated to stocks than it would "flee to safety" Treasuries. I own this fund and this etf can provide diversification to the bond portion of your portfolio, but would be a poor choice as a standalone ballast to your equity investments.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by rkhusky »

There's a reason that the SEC yield of VCIT is 4.37% vs the SEC yield of VGIT (Int. Treasury) being 2.90% - there is more risk.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by exodusNH »

000 wrote: Thu May 19, 2022 5:41 pm
NoRoboGuy wrote: Thu May 19, 2022 4:58 pm Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
Would the fund be required to dump them if they fall past BBB? If so, I think that is a pretty big reason to be concerned, and a potential future buying opportunity for others.
Yes. They're dropped. Those companies become "fallen angels". There are several funds that will buy them.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by secondopinion »

exodusNH wrote: Thu May 19, 2022 11:06 pm
000 wrote: Thu May 19, 2022 5:41 pm
NoRoboGuy wrote: Thu May 19, 2022 4:58 pm Back to the point of the initial thread...is anyone concerned that 55% of VCIT is BBB? Yes, it is "investment grade" (barely), and yes VCIT has this ratio because there is a greater amount of BBB-rated bonds comprising the underlying index.

Is this a reason to be concerned?
Would the fund be required to dump them if they fall past BBB? If so, I think that is a pretty big reason to be concerned, and a potential future buying opportunity for others.
Yes. They're dropped. Those companies become "fallen angels". There are several funds that will buy them.
FALN is such an ETF. https://www.ishares.com/us/products/283 ... d-bond-etf

Good if one like that sort of thing.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by alex_686 »

NoRoboGuy wrote: Thu May 19, 2022 9:02 pm Let's say that for some random reason <s> we just happen to get into a recession with 55% of the portfolio rated BBB. I wonder if the low risk profile (2 out of 5) assigned to VCIT is just a wee bit overstated...
It would still be a 2 because it would be relatively stable compared to the stock market.
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Re: Vanguard Corporate Bond (VCIT) quality

Post by McQ »

All: if you have more than a passing interest there is quite a lot of historical data out there on corporate bond spreads. Fed Reserve publications have tracked Aaa, Aa, A and Baa yields since January 1919 (NBER.org to fill gaps). Moody's ratings go back to 1909, but Moody's didn't take the indexes that far when they back-calculated them in the later 1920s.

The distribution of ratings (proportion Aaa vs BBB, say) has not been constant, to say the least. There were four macro-waves:

1. 1909 to 1929. Virtually all bonds were rated investment grade or better. Even Baa bonds were a small proportion. No one wanted to lend money for 40 years (a typical maturity in those days) except on sound credit. High-yield bonds were few and far between, mostly fallen angels.
2. 1929 to 1945. The proportion of Baa and high yield bonds soared in the Depression and it took WW II prosperity to recover. Not a few Aaa bonds became Baa bonds--or worse.
-The source here is Hickman, search NBER.org
3. 1945 to 1965. By the end of the war, work outs were mostly complete, and most large bonds were once again investment grade. Over the years a few railroads, once blue chips, ended up back in the Ba or B pile, as that industry sank into desuetude. But once again, a majority of bonds were rated Aaa or Aa. Defaults almost disappeared.
-The source here is Atkinson at NBER.org
4. As the 1960s proceeded, the proportion of Baa bonds began to climb. By the 1980s, under the magic touch of Michael Milken, the high yield category exploded. At the same time, the shift from Aaa to Baa as the major proportion of investment grade bonds gathered steam, until we reach the 55% count seen in the indexes today.
Deteriorating credit quality? Smarter credit rating agencies, more skeptical? A discussion for another day.

PS. through the 1920s the Ba grade, not Baa, marked the bottom of the investment group. The current idea of "investment grade" dates to New Deal bank regulation: as in, "banks, if you own anything worse than Baa, gumnint is coming done on you."
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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