A new study points out that many bonds funds are less safe than their average bond ratings seem. Lower-rated bonds default at increasing rates, not at rates that increase in a constant fashion. For example, an imaginary portfolio of 50% AAA bonds and 50% A bonds will carry an average rating of AA—but the default risk will be higher than if the portfolio were 100% AA.
One article about the study remarks:
Craig McCann, principal at Securities Litigation and Consulting Group and one of the study’s authors, cites their analysis of 285 taxable intermediate bond funds from Morningstar’s database, in which they excluded all of the duplicative share classes: 47 were graded AAA; 193 were AA; 38 were A; and seven were B. Of those funds, they found that only 18, or about 6%, warranted the grade they were given; 153 of the funds — more than half — should have been a letter grade lower; and, 112, or 40%, should have been two letter grades lower.
You can read the whole white paper here.
The point is that averages can hide a lot of things. Statistics are extremely useful, but you still need to dig in and understand what you are looking at. Due diligence for any investment product must be done carefully so that you know what to expect.
