Heading into this year, there was plenty of chatter and concern about a potential raft of downgrades for BBB-rated corporate debt, or the corporate bonds with the lowest investment-grade ratings. Bonds with those ratings are one to three notches above junk territory.
The iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), the largest investment-grade corporate bond exchange traded fund, holds nearly 2,000 corporate bonds, 49.66% of which are rated BBB.
LQD seeks to track the investment results of the Markit iBoxx USD Liquid Investment Grade Index composed of U.S. dollar-denominated, investment-grade corporate bonds. LQD allocates 95 percent of its total assets in investment-grade corporate bonds to mitigate credit risk.
“Since the 2008/2009 financial crisis, BBB-rated bonds have seen significant growth in the U.S.,” said S&P Dow Jones Indices in a note out Wednesday. “Today, they constitute more than half of the U.S. investment-grade bond market. The increasing share of BBB-rated bonds has dragged the S&P U.S. Investment Grade Corporate Bond Index average credit rating lower, and is accompanied with higher leverage of BBB-rated bond issuers.”
Even with the concerns surrounding BBB-rated corporates, investment-grade corporate bond ETFs are performing well this year. LQD is up 5.67% year-to-date, a performance matched by the ProShares Investment Grade—Intr Rt Hdgd (CBOE: IGHG), which allocated half its weight to BBB-rated debt at the end of 2018.
IGHG tracks the performance of the Citi Corporate Investment Grade (Treasury Rate-Hedged) Index with long positions in investment grade corporate bonds issued by both U.S. and foreign domiciled companies. This is particularly important during market downturns when the propensity for a company to default on its debt is higher. As such, IGHG focuses on investment-grade issues to reduce credit risk.
IGHG’s steadiness to start 2019 indicates the fund has utility in more than just rising rate environments. After all, it is widely expected the Fed will not raise rates this year and the fund is still performing admirably.
“The credit fundamentals of investment-grade bonds have evolved since 2007. Leverage for BBB-rated bonds as a whole has risen, as measured by net debt/EBITDA and debt/enterprise value (EV),” according to S&P Dow Jones. “Since 2007, the net debt/EBITDA ratio for U.S. issuers of investment-grade bonds went up from 1.49x to 2.16x at the end of 2018, while net debt/EBITDA for issuers of BBB-rated bonds rose faster, to an elevated 3.08x.”
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