Investment-grade debt and bond-related exchange traded funds just can’t catch a break this year.
U.S. investment-grade debt has experienced one of the worst performance of any major sector of the fixed-income asset class so far this year, CNBC reports.
The iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) declined 4.7% year-to-date, compared to the 2.5% dip in the Bloomberg Barclays U.S. Aggregate Bond Index.
ETF investors have also been avoiding the asset category, pulling some $3.5 billion from LQD so far this year, according to XTF data.
The Federal Reserve’s rising interest rates have been a main contributing factor in the downfall of investment-grade bonds this year. As the Fed hikes the short-term fed funds rate, longer-duration investment-grade bonds with historically low yields have appeared less attractive.
“The hit from interest rates has been a big deal,” Elaine Stokes, a fixed-income strategist and manager of several bond funds at Loomis Sayles, told CNBC.
“The spread is still not very attractive,” Stokes added. “The yield and credit spread curves are too flat. You’re not getting paid enough to go down in quality or longer in term.”
Volume of Debt
Some fixed-income observers are also concerned about the amount of debt floating around. The volume of debt issued by investment-grade companies since the financial downturn could be problematic if the economic cycle sours. Corporate investment-grade bonds now make up $6 trillion, compared to $2 trillion before the financial crisis. While some of the new issues is a result of economic growth, corporate leverage remains much higher than it was in the last cycle, which leaves them open to greater credit risk in case of a sudden reversal.
Related: Inside ‘SLQD’ Short-Term, Investment-Grade Corporate Bond ETF
Furthermore, credit ratings are skewed toward the lower end of the investment-grade spectrum. There are only two corporate issuers in the United States rated AAA while bonds rated BBB make up 50% of the Bloomberg Barclays investment-grade bond index, compared to 38% prior to the financial crisis.
“Leverage is way up,” Erin Lyons, U.S. credit strategist for CreditSights, told CNBC. “The concern is over how much riskier BBB bonds are now.”
“Some think many of them shouldn’t have investment-grade ratings,” she added.
For more information on the fixed-income market, visit our bond ETFs category.