Investors have piled into high-quality, investment-grade corporate bonds and related exchange traded funds, pushing down yield spreads on corporate debt to less than one percentage point from benchmark Treasuries.
According to Barclays data, debt from U.S. investment-grade companies now yield 0.97 percentage point more than benchmark U.S. Treasuries, the first time the spread has diminished to below one percentage point since July 2007, reports Mike Cherney for the Wall Street Journal. [Bond ETFs Beloved in 2014]
The yield on 10-year Treasury bonds was hovering around 2.53% Thursday, down from about 3.0% at the start of the year.
The iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), which has an effective duration of 7.71 years and a weighted average maturity of 11.7 years, shows a 3.06% 30-day SEC yield. LQD has gained 5.9% year-to-date as investors rushed back into the fixed-income market in response to falling interest rates this year. [Safe Bond ETFs Outperforming in Corporate Debt Market]
In comparison, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) has an effective duration of 7.61 yeras, a weighted average maturity of 8.5 years and a 2.36% 30-day SEC yield. IEF is up 4.9% year-to0date.
The yield differential, or spread, beyond the interest paid on U.S. Treasuries reveals the extra risk premium investors seek to investment in companies that are more likely to default than the U.S. government. However, with yields on corporate debt falling closer to U.S. Treasury yields, investors may be as confident in corporate America as they are in the U.S.
“Corporate bonds have higher yields than U.S. Treasury bonds with like maturities,” according to Morningstar analyst Timothy Strauts. “This can be explained largely by a default risk premium. Corporations may periodically default on their debts, whereas the U.S. government will not. Investors demand compensation for this risk in the form of a default risk premium. Credit spreads measure the default risk of a bond or a portfolio of bonds.”
In the current low rate environment and slowly expanding economic conditions, the dropping corporate debt yields reflect investors’ confidence that highly rated companies will remain afloat, or the lower probability of defaults.
U>S. companies have sold $618 billion in investment-grade debt this year, the most on record and up from $557 billion for the same time last year. Meanwhile, investors have funneled $33.5 billion into high-grade U.S. corporate-debt mutual funds so far this year, compared to $21 billion for all of 2013.
iShares iBoxx $ Investment Grade Corporate Bond ETF
For more information on corporate debt, visit our corporate bonds category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own shares of LQD.
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