Dodge Junky, Risky Debt With This Corporate Bond ETF | ETF Trends

With Treasury yields recently having breached the 1% level, advisors and investors are scrambling to source yield with bonds, but with the coronavirus knocking high-yield corporate debt down a peg, other corporate bond strategies could come into focus.

The current environment is trying for corporate bonds and the related ETFs. With elevated concerns regarding a raft of potential downgrades for corporate debt hovering just above junk status, some bond investors are emphasizing fundamentals. The WisdomTree Fundamental U.S. Corporate Bond Fund (CBOE: WFIG) is an ETF that can help with that objective.

WFIG’s fundamental focus helps it avoid risky investment-grade bonds that are vulnerable for downgrades to junk status, such as the recently downgraded Kraft Heinz Co. (NASDAQ: KHC).

“Needless to say, prices on Kraft’s bonds sold off materially, in some cases more than 10%. Consider the price of the Kraft Heinz largest corporate bond (4 3/8% due 6/1/46), with an amount outstanding of $3 billion,” said WisdomTree in a recent note. “After disappointing earnings and the downgrades by S&P and Fitch, the bonds fell from $101.75 on Wednesday, February 12, to $91.58 by end of day on Friday, February 14, a drop of 10.2 cents on the dollar. By Wednesday, February 19, the bonds have recovered by 3.47 cents on the dollar but still are significantly depressed.”

WFIG Stands Out

Home to nearly 400 bonds, WFIG has an effective duration of almost eight years. The fund has 30-day SEC yield of 2.33%, according to issuer data. Importantly, WFIG’s methodology helps investors reduce risk.

“WisdomTree believes that there are trends in corporate bond fundamentals that can be used to systematically identify problematic credits. Our WisdomTree Corporate Bond Indexes use three metrics to screen out bonds: return on invested capital (ROIC), total debt to total assets, and free cash flow to debt service,” according to WisdomTree. “All three metrics screened poorly for Kraft Heinz, and the corporate bond for Kraft was subsequently excluded from the WisdomTree Corporate Bond Indexes.”

WisdomTree has identified deteriorating cash flows, rising leverage, and weakening profitability compared to peers as effective markers for potential credit concerns. WisdomTree believes eliminating these issuers can generate a considerable improvement in the strategy’s downside risk protection.

“One metric that stood out was ROIC, which deteriorated significantly over the past two years,” notes WisdomTree. “The large drop in ROIC in Q4 2018 was due to a fall in net income, input into the ROIC ratio. Kraft Heinz had a $16 billion goodwill and intangibles write-off. This one-time write-off occurred because management believed they were overvaluing their brands.”

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.