Investors looking for the income benefits of investment-grade corporate bonds while limiting duration risk have plenty of options to consider in the world of ETFs. The WisdomTree Fundamental U.S. Short-Term Corporate Bond Fund (CBOE: SFIG) uses a fundamentally-weighted approach to deliver corporate bond exposure with less duration risk.
Bond funds hold a collection of debt with varying maturities, buying and selling debt securities to maintain their short-, intermediate- or long-term strategy. When it comes to bond ETFs, investors should look at the duration, or a bond fund’s measure of sensitivity to gauge their investment’s exposure to changes in interest rates – a higher duration means a higher sensitivity to shifts in rates.
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.
“At the short end of the curve, spreads tend to be much more driven by economic fundamentals,” said WisdomTree in a recent note. “For this reason, we believe that investors concerned about the relationship between credit spreads and issuance should bias their portfolio to the shorter end.”
SFIG’s Utility
Bond ETF investors can move down the yield curve with shorter duration bond funds. Duration is a measure of a bond fund’s sensitivity to changes in interest rates, so a shorter duration reflects a lower negative response to higher interest rate.
SFIG’s effective duration is just 2.36 years, but its 30-day SEC is still solid at 3.04%.
In the current rising rate environment, a number of financial advisors are suggesting investors to treat fixed income like the sun and limit prolonged exposure. In this case, as the Federal Reserve’s predilection for raising interest rates does not appear to be changing anytime soon, it’s best to take advantage of these short-term rate adjustments by limiting duration.
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SFIG also mitigates some of the risks associated with highly leveraged corporate borrowers.
“Fortunately for investors, these are exactly the same factors that WisdomTree identified when creating our fundamentally weighted fixed income indexes. While a market cap-weighted approach owns every bond regardless of its fundamentals, in WisdomTree’s approach, we seek to eliminate the bottom 20% of issuers based on leverage, return on invested capital (a measure of profitability) and free cash flow over debt service (a measure of debt sustainability),” according to WisdomTree.
For more information on the fixed-income market, visit our bond ETFs category.