Investors who have lent money at low rates this year to high-profile, deep-pocketed U.S. companies got a good look at the down side of that strategy

May 28, 2013, 7:28 p.m. ET

When Model Borrowers Bite Back

By MIKE CHERNEY

Investors who have lent money at low rates this year to high-profile, deep-pocketed U.S. companies got a good look Tuesday at the down side of that strategy.

The prices of bonds issued by Apple Inc., AAPL -0.83% Merck & Co., MicrosoftCorp., MSFT +2.19% Nike Inc. NKE +0.78% and McDonald’s Corp. MCD +0.95%tumbled along with U.S. Treasurys, underscoring the risk of purchasing high-rated corporate bonds at a time when interest rates are near record lows. These high-grade companies have raised nearly $27 billion in the past month on bonds that often yield within a percentage point of U.S. government debt.McDonald’s is part of a group of high-grade companies, including Apple and Microsoft, that have raised nearly $27 billion in the past month. Above, a McDonald’s in Marion, Ind.

High-rated, low-yielding debt of household-name companies has attracted strong interest because of the low perceived risk that these companies will fail to make good on their obligations.

But such debt often is hit hard when U.S. Treasury bonds sell off, as they did Tuesday, and the low yields that investors receive in buying these bonds offer little cushion for the paper losses spurred by price declines.

“It could be some scary times” in the investment-grade market, said Dan Hannis, a corporate-bond trader at William Blair. He said prices could be pushed down further when individual investors rush to sell their investment-grade mutual-fund shares after seeing consistently negative returns.

When Treasury yields rise, investment-grade bond yields tend to climb in lock step. That pushes down prices of the corporate bonds, since prices fall when yields increase. Bonds of lower-rated companies typically fall less hard because the debt pays more interest, giving investors a bigger cushion before their returns turn negative. Bonds that have longer maturities also are more sensitive to changes in interest rates. Lower-rated companies don’t issue as much longer-term debt.

The 10-year Treasury note fell 1 2/32 in price, after robust housing and consumer-confidence reports stoked expectations that U.S. economic growth will cause the Federal Reserve to scale back its support for financial markets.

Many investment-grade bond prices fell in price as well, according to MarketAxess.

Apple’s 10-year bond fell by 1.15% to 95.85 cents on the dollar, while its 30-year bond tumbled 1.98% to 92.6 cents on the dollar. The most actively traded investment-grade bond Tuesday was a 10-year bond from J.P. Morgan Chase JPM +1.75% & Co., which fell in price by 0.73% to 98.69 cents on the dollar, according to MarketAxess.

Junk-bond prices didn’t fall as sharply as their higher-rated cousins, according to MarketAxess. The heavily traded 10-year bond of Constellation Brands, STZ +0.89%which is rated below investment grade, fell 0.25% to 99.25 cents on the dollar, according to MarketAxess.

Investors in higher-rated debt have suffered in other rising-rate periods over the past year. Those who bought triple-A-rated corporate debt posted a 0.8% negative return from Dec. 6 to Feb. 13, when 10-year Treasury yields rose 0.47 percentage point. Triple-C-rated debt, in contrast, returned a positive 4.13%, according to an analysis from Barclays BARC.LN +2.56% .

According to an analysis from William Blair, Apple’s 10-year bonds would have traded at 97 cents on the dollar if 10-year Treasurys were at 2%. If rates were to rise to 3%, the price would plummet to 88.88 cents on the dollar, a loss of 8.37%.

In contrast, double-B-rated General Motors Financial Co. Inc., which recently sold more than $2 billion in debt, would see prices on its 10-year bonds fall only 7.72% if rates went from 2% to 3%, from 100.4 cents on the dollar to about 92.6 cents.

To be sure, not all investors are convinced rates will rise significantly in the short term. Fed Chairman Ben Bernanke said steps could be taken toward reducing its bond-buying program, designed to stimulate the economy by keeping rates low. He also said he was cautious about moving too quickly.

Rob Crimmins, portfolio manager at RS Investments, said he sold Treasury bonds recently and purchased debt from pharmaceutical giant Merck, which is rated double-A by Standard & Poor’s Ratings Services. Mr. Crimmins, who helps manage $2 billion in three bond mutual funds, bought 10-year bonds from Merck that were offering 0.87 percentage point in extra yield compared with similar-maturity Treasurys. On Tuesday, they were yielding on average 0.84 percentage point more, according to MarketAxess.

“It is sort of a struggle right now,” said Mr. Crimmins, adding that he would rather not lock in these long-term low rates, but also wants to avoid paltry returns by holding on to cash.