Corporate Bonds Could Be in a Precarious Position | ETF Trends

Unless corporations are able to pull off the ultimate escape artist trick, they won’t be able to get away from higher interest rates, which could put corporate bonds in a precarious position.

A MarketWatch report noted a particular Goldman Sachs analysis that addressed the $1.8 trillion mass of corporate debt that will be due in the next couple of years. The problem is the current high-interest rate environment could force corporations to take on more expensive debt, thereby forcing them to slash costs, which could include layoffs.

Goldman Sachs’ economic team is predicting that a 2% increase in interest expenses could hit corporations in 2024 and then more than double to 5.5% by 2025. As interest expenses rise, corporations’ willingness to spend heads in the other direction — this includes payrolls falling in an effort to curb costs.

“We find that for each additional dollar of interest expense, firms lower their capital expenditures by 10 cents and labor costs by 20 cents, about half of which comes from reduced employment and half of which comes through lower wages,” the economics team said, per the MarketWatch report.

Corporations that are in a more tenuous position could issue bonds to finance the expectation of higher costs, potentially with higher yields attached to make them more attractive to investors. As such, corporate bonds could continue offer yield-hungry fixed income investors with an ideal option.

Still a Worthy Yield Option

Yield seekers who are willing to accept the higher credit risk and rate risk associated with long-term bonds can take a look at the Vanguard Long-Term Corporate Bond Index Fund ETF Shares (VCLT), which has a 30-day SEC yield of 5.68% (as of August 7). The fund seeks to track the performance of a market-weighted corporate bond index with a long-term dollar-weighted average maturity.

The fund, which also features a low 0.04% expense ratio, employs an indexing investment approach designed to track the performance of the Bloomberg U.S. 10+ Year Corporate Bond Index. This index includes U.S. dollar-denominated, investment-grade, fixed-rate, taxable securities issued by industrial, utility, and financial companies, with maturities greater than 10 years.

Fixed income investors who want to add an environmental, social, and governance (ESG) component to their corporate bond exposure may want to look at the Vanguard ESG U.S. Corporate Bond ETF (VCEB). With its 30-day SEC yield of 5.35%, maturities are primarily in the intermediate range (6.8 years) and include investment-grade corporate debt.

VCEB seeks to track the performance of the Bloomberg MSCI US Corporate SRI Select Index, which excludes bonds with maturities of one year or less and with less than $750 million outstanding, and it is screened for certain ESG criteria by the index provider, which is independent of Vanguard. It excludes bonds of companies that the index sponsor determines are involved in and/or derive threshold amounts of revenue from certain activities or business segments related to adult entertainment, alcohol, gambling, tobacco, nuclear weapons, controversial weapons, conventional weapons, civilian firearms, nuclear power, genetically modified organisms, or thermal coal, oil, or gas.

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