Corporate bonds and related exchange traded funds have generated solid returns over the past few years as investors shifted away from low-yielding Treasuries and into riskier assets. However, potential investors should not get their hopes up as future returns may be tempered.
The iShares iBoxx $ Investment Grade Corporate Bond (NYSEArca: LQD) has returned 12.1%, 9.1%, 8.9% and 11.7% for the years from 2009 to 2012. [2012 was the Year of the Bond ETF]
“Is this level of performance realistic going forward? We think the answer is no,” Timothy Strauts, Morningstar ETF analyst, said. “That doesn’t mean you should avoid corporate bonds, but you should have realistic expectations about future returns.”
Back in 2009, the BofA Merrill Lynch US Corporate BBB Index had a yield of 9.8%, but the index yield has dropped to 3.3%, near historical lows. Yields and bond prices have an inverse relationship – as yields dropped over the past few years, bond prices have been rising. LQD has a 2.78% 30-day SEC yield. [Investors Pile Into Corporate Bond ETFs as Credit Quality Declines]
Investment-grade corporate debt provides attractive yields compared to U.S. Treasuries because of their credit risk, but they remain relatively safe. Long-term investors utilize corporate bond investments, like LQD, as part of a diversified fixed-income portfolio. On the other hand, tactical traders would consider the asset when they believe the corporate bond market is underpriced compared to Treasuries.
Potential investors should also be aware that corporate-bond ETFs, like LQD, may favor a particular area. For instance, LQD has 33% of its portfolio in financials.