Credit analyst recommendations are forecasts about the direction of credit spreads vs. a benchmark, sector or peer group. Making a positive recommendation on a high-quality bond with a tight credit spread puts an analyst in a difficult spot; the only way that bond would outperform would be if riskier bonds performed poorly. For lower-rated issuers where credit spreads are wider, analysts have more room to make positive recommendations with the benefit of additional spread carry, and those analysts who are bristling with confidence make more of them. If that is the case, it presents a problem for credit managers; a greater number of outperform recommendations for lower-quality issuers skews the list of investment ideas that managers choose from quite significantly.
To test this view, we pulled every investment-grade corporate bond recommendation from five publishing sell-side research providers. We found BBB rated issuers get most of the attention from analysts: nearly half of the lowest-rated issuers were covered by research analysts. In the top rating categories, only 28% were covered.
It is true there are more lower quality than higher quality issuers in the investment-grade market, with more than 700 BBB rated issuers vs. about 400 issuers with ratings of A or above. But our analysis confirmed a significant tilt toward outperform recommendations in lower-quality or riskier bonds.
Looking across rating categories within investment grade, outperform recommendations for BBB rated issuers outnumbered underperform recommendations by more than 2-to-1 (289 outperform vs. 129 underperform.) Among higher quality issuers — those rated A or better — the outperform-underperform split was more balanced, with 70 outperform vs. 99 underperform recommendations. And when you compare 289 outperform recommendations of BBB rated issuers to only 70 outperform recommendations on higher quality issuers, the skew toward risky ideas is more than 4-to-1.