Corporate Bond ETFs Could Retreat

The iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) is down just 1% this year, but renewed risk appetite, which is bolstering riskier assets, could send investors out of previously beloved safe-haven assets.

Due to the growing popularity and vast liquidity of corporate bond-related ETFs, more investors have turned to ETFs as a way to play the corporate debt market as opposed to trading less liquid individual debt securities. For instance, according to Markit, a monthly average of 7 billion euros of contracts linked to high-yield bond indices in Europe and the U.S. were bought and sold since the market started electronically confirming trades in March.

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.

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]

“US corporate bonds started 2016 with the worst performance in 16 years and borrowing costs for investment-grade companies soared to a four year high in late January as Standard and Poor’s warned on the outlook for corporate borrowers. Morgan Stanley was out with a call on February 8th noting that Investment Grade Bonds are cheap and one of the few attractively valued, lower-beta investment opportunities in fixed income. Investment grade valuations have fallen to recessionary levels as credit risk has risen,” according to See It Market.