Avoid Risky Corporate Bonds but Attain Yield With This ETF

Record issuance in the corporate bond market is giving fixed income investors an abundance of opportunities. However, due diligence is necessary as high-yielding bonds may uncover a risky proposition that doesn’t quite match an investor’s risk profile.

As the Financial Times reported, risky corporate bonds are in a precarious position. With interest rates still relatively high, they are having to tread water in order to keep servicing current debt until interest rates finally fall. With a data-dependent Federal Reserve that’s keen on holding rates steady for longer than expected, this could put companies at risk for defaulting on debt.

As the FT report noted, the evidence is in the spread, meaning the amount high-risk companies must pay to issue debt versus their safe-haven Treasury counterparts. The spread has reached 9.28, which is 77 basis points higher than what it was in December.

Furthermore, the avenues for borrowing are simply drying up for high-risk companies. The current borrowing environment favors more fundamentally sound companies and those with the lowest quality could proverbially get left in the cold, thus sparking a potential wave of defaults.

“Our view is that for reasonably high-quality businesses, there will be interesting ways to access capital,” said Ed Testerman, partner at investment management firm King Street Capital. “[But] for the lowest quality companies, there will be fewer options at their disposal, which may drive more defaults.”

All this said, it begs the question of how can fixed income investors get the attractive yields of corporate bonds while mitigating risk?

An Investment-Grade Option

Investors who are intrigued by the prospect of getting corporate bond exposure may not want to take on the additional credit risk, especially those with high-risk profiles. That said, they may want to focus their capital on investment-grade debt debt. Rather than opt for single holdings of debt from various companies, they can narrow down their focus on one exchange-traded fund (ETF): the Vanguard Total Corporate Bond ETF ETF Shares (VTC)

For yield seekers, VTC presents a compelling opportunity. It’s an ideal time for fixed income investors to obtain yields now before the Fed breaks out of their rate-holding pattern and starts to loosen monetary policy. Furthermore, VTC provides a corporate bond portfolio with diversification by including debt with a variety of maturity dates. It focuses on investment-grade bonds to minimize credit risk. As of February 15, the fund has a 30-day SEC yield of 3.84%. It also sports a low expense ratio of 0.04%.

VTC employs an indexing investment approach designed to follow the performance of the Bloomberg U.S. Corporate Bond Index, which measures the investment-grade, fixed-rate, taxable corporate bond market. The index includes U.S.-dollar-denominated securities publicly issued by industrial, utility, and financial issuers.

For more news, information, and strategy, visit the Fixed Income Channel.