How to Catch the Corporate Bond ETF Wave

Behind the scenes of the equity rally, corporate bonds of both type are enjoying a rally all their own, leading to a surge in related exchange traded funds (ETFs).

Thanks to a better-than-expected earnings season, investors are increasingly willing to accept some risk. The average “junk” rated company is not distressed anymore, meaning yields have fallen to less than 10% above the benchmark Treasury bond, say Annelena Lobb and Rob Copeland for The Wall Street Journal. Yields on higher-quality corporations are also sharply lower.

As yields fall, bond prices rise. What’s the case for corporate bonds now?

• Corporate bonds are appealing to investors who want to hedge their bets, as they can serve as a cushion against the unknown conditions for the future of the market.
• The defense? Even if the default rate on high-yield corporate bonds hits the projected 14% rate by the end of 2009, returns from the junk that survives would more than offset the default-related losses, says one market executive.
• The overall health of companies is improving, with 285 companies on a watchlist versus 290 in June and a record 300 in April, Matt Krantz for USA Today reports.
• Investor appetite is ripe for corporate bonds. U.S. companies raised $903 billion year-to-date, up from $548 billion at the same time last year.

• iShares iBoxx $ High Yield Corporate Bond (HYG): up 16.2% year-to-date

• iShares iBoxx $ Investment Grade Corp. Bond (LQD): up 4.6% year-to-date

• SPDR Barclays Capital High Yield Bond (JNK): up 22.7% year-to-date

For more stories about corporate bonds, visit our bond category.

For full disclosure, Tom Lydon’s clients own shares of LQD.