Is High Yield Underperformance Clearing the Way for Quality?

After investors got washed through the May 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.

“The market was clearly pricing in a good chance of a trade deal in May and that did not happen,” said Todd Schomberg, senior portfolio manager for Invesco Fixed Income. “Not surprisingly, some of the riskier parts of the market underperformed during the month … and yields went down quite significantly during the month.”

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

“I wouldn’t call it a full-blown flight to quality,” said John Hollyer, principal and global head of Vanguard Fixed Income Group. “We don’t view this necessarily as a dramatic departure of what we were expecting, but to the extent that the stock market declines or corporate borrowing costs rise, it’s a tightening of financial conditions, which could be like a knock-on effect of trade. So, we worry a bit about that.”

Investment-Grade Options

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.