Investors Need to Refocus on Quality in the Bond Market

Rate cuts by the Federal Reserve and fears of a global economic slowdown looming, it’s getting more difficult for investors to find the yield they desire. However, they should refocus on quality as the scramble for safe-haven assets could continue through the rest of 2019.

Per a Bloomberg report, a “steep drop in yields wiping out the tax advantages of some tax-exempt securities, investors are hunting for higher payouts. That’s driven yields on the riskiest tax-exempt securities down to about 4%, the lowest since at least 2003, and in turn spurred an increase in sales from the most default-prone segments of the market. Shopping malls, centers for novel health-care treatments, factories seeking to turn trash into fuel and speculative real-estate developments like the one outside of Denver — all have recently sold tax-exempt debt through local government agencies.”

With the high yield market getting more risky, it’s necessary for investors to shed some of that risk and get more strategic with their capital allocation. This could mean looking to options like investment-grade debt for higher yielding income sources.

After investors got washed a volatility cycle thanks to trade wars, that may have tamped down their risk-on sentiment and this is where a potential buying opportunity exists for investment-grade debt. As a result, high yield has underperformed lately as investors flocked to the safer confines of quality oriented assets like investment-grade debt issues.

With Treasuries yielding just above 2 percent for the 10-year benchmark note versus almost 3 percent a year ago, investors are sourcing for avenues of income without the added risk. Could this mean investors knocking down the doors to quality driven debt?

Investment-grade corporate bond-focused fixed-income ETF options include the iShares Intermediate Credit Bond ETF (NASDAQ: CIU)iShares iBoxx $ Invmt Grade Corp Bd ETF (NYSEArca: LQD) and Vanguard Interm-Term Corp Bd ETF (NASDAQ: VCIT).

CIU tracks the investment results of the Bloomberg Barclays U.S. Intermediate Credit Bond Index. CIU focuses on investment-grade corporate debt and sovereign, supranational, local authority and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to ten years.

LQD seeks to track the investment results of the Markit iBoxx® USD Liquid Investment Grade Index composed of U.S. dollar-denominated, investment-grade corporate bonds. LQD allocates 95 percent of its total assets in investment-grade corporate bonds to mitigate credit risk.

VCIT seeks to track the performance of a market-weighted corporate bond index with an intermediate-term dollar-weighted average maturity, namely the Bloomberg Barclays U.S. 5-10 Year Corporate Bond Index. While VCIT holds debt issues with maturities between 5 and 10 years, they are all investment-grade holdings to minimize default risk.

For more trends in fixed income, visit the Fixed Income Channel.