Although some investors recently departed investment-grade corporate bond exchange traded funds due to debate regarding the Federal Reserve’s next policy move, funds such as the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), SPDR Barclays Short Term Corporate Bond ETF (NYSEArca: SCPB) and the SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEArca: ITR) still merit consideration by investors.
Investment-grade-rated debt issuers halted sales in August as a response to the sudden spike in volatility and uncertainty over a potential September Federal Reserve rate hike, reports Cynthia Lin for the Wall Street Journal.
The good news is that investment-grade corporates now look inexpensive and investors can use select ETFs to gain exposure to lower duration bonds that are less sensitive to fluctuations in interest rates.
The yield and bond’s price have an inverse relationship, so bond funds with long durations would experience large price drops if rates were to rise. In contrast, short-duration bond funds will experience more muted volatility in case of sudden rate changes.
“IG remains cheap by any number of metrics; for example, the ratio of IG to HY [high yield]spreads remains almost two standard deviations from normal. But every bit as important is that this cheapness is in large part the result of a transient factor — supply. The IG / HY relationship in the synthetic market, which is clearly less sensitive to cash market supply, is less than one standard deviation from normal,” according to a Credit Suisse note posted by Amey Stone of Barron’s.
SCPB has a 1.95 year duration and a 1.69% 30-day SEC yield. ITR has a 4.38 year duration and a 2.72% 30-day SEC yield. Fixed-income investors can go down the yield curve to short-duration bonds to hedge against rising rates. [Rate Hike Still Looms for Bond ETFs]
Bond ETFs track a basket of fixed-income securities. Consequently, the ETFs are only as liquid as their underlying assets. In times of heightened market volatility, the bond ETFs may see a heavy redemptions, and without the necessary buyers in the underlying market, bid-ask spreads with rise and prices could fall even further. [How ETFs Are Traded]
“Constituents of the iBoxx $ Liquid Investment Grade index and those of LQD have exhibited considerably more liquidity than the 16,500 investment grade $ bonds covered by the Markit bond universe in the first quarter of this year,” according to Markit.
SPDR Barclays Intermediate Term Corporate Bond ETF
Tom Lydon’s clients own shares of LQD.