While bonds have been the default safe haven amid the recent volatility in the equities market, it can be daunting to look at all the options, such as government debt and corporate bonds. One way to go about building a proper bond portfolio is to consider the risks first and foremost.
When it comes to investing in bonds, there are typically two camps, according to MarketWatch’s Jared Dillian.
“If you are in the latter camp, let me tell you how you should build a bond portfolio,” wrote Dillian. “The best way to build a bond portfolio is to start by thinking about the risks. A portfolio of bonds can go down, you know.”
Go for the Quality
“So the first consideration is the direction of interest rates, known as duration risk,” Dillian said. “For U.S. Treasury bonds, that is pretty much the only risk. For other types of bonds, there are other risks. Corporate bonds can and do default. They haven’t in a while, but they will someday. More importantly, the price of these bonds will decline as the market perceives companies to be less creditworthy.”
Market volatility is opening the pathway for investors to flock to safe-haven government debt, which is causing yields to fall. As such, a yield curve inversion—a typical sign ahead of a recession—is forming with respect to the 2- and 10-year Treasury yields.
Given the latest market volatility, getting that bond exposure is still a must. Investors looking to gain broad-based exposure to bonds can look at funds like the ProShares S&P 500 Bond ETF (NYSEArca: SPXB). The fund seeks investment results that track the performance of the S&P 500®/MarketAxess Investment Grade Corporate Bond Index, which consists exclusively of investment-grade bonds issued by companies in the S&P 500.
Another area to look at is high-quality credit of the corporate variety.
“Well, if you own a high-quality, investment-grade corporate bond fund, the most it can probably go down because of credit concerns is about 5%-7%. If it is a fund that is concentrated in BBB credits, perhaps a bit more” Jillian said.
Investment-grade corporate bond-focused fixed-income ETF options include the iShares Intermediate Credit Bond ETF (NASDAQ: CIU), iShares iBoxx $ Investment Grade Corp Bd ETF (NYSEArca: LQD) and Vanguard Interm-Term Corp Bd ETF (NASDAQ: VCIT). Investors looking for broad-based core bond exposure can look to a fund like the iShares Core US Aggregate Bond ETF (NYSEArca: AGG).