Credit spreads are tightening, which could be causing investors to shy away from the extra risk associated with high yield, but there are safer options like municipal bonds and the Vanguard Tax-Exempt Bond ETF (VTEB).
The past month saw equities get racked with a bout of volatility as inflation fears put investors in a state of unease. Given that rates are still low by historical standards, fixed income investors may be starting to weigh in the risks of higher yield.
“The US junk bond market has begun wavering on rising inflation worries, raising the risk that the powerful rally since the depths of the pandemic in the debt issued by the riskiest corporate borrowers may be coming to an end,” a Financial Times article noted. “The high-yield bond market has been a shelter for investors seeking to avoid the volatility in stocks and government bonds this year, but these riskier assets have now begun flashing signs of caution.”
In the meantime, investors can check out municipal bonds, which are more stable. Default odds for municipal bonds are lower given that municipal bonds are backed by state and local governments.
VTEB tracks the Standard & Poor’s National AMT-Free Municipal Bond Index, which measures the performance of the investment-grade segment of the U.S. municipal bond market. MUB seeks to track the investment results of the S&P National AMT-Free Municipal Bond Index, which also measures the performance of the investment-grade segment of the U.S. municipal bond market.
The sampling approach means that both funds hold a subset of bonds within the index in order to replicate the yield, duration, and credit quality of the debt. This method allows the funds to avoid trading expensive bonds that could harm performance, and, in addition, minimize tracking errors.
When it comes to obtaining yield via safer government debt like Treasury notes, fixed income investors must go further out on the yield curve in order to get anything above 2%. This means having to step out all the way to the 20-year Treasury notes.
VTEB can get investors to that 2% mark in the convenience of an ETF wrapper. It’s an option for investors to park their cash while the high yield debt market sorts itself out.
For more news, information, and strategy, visit the Fixed Income Channel.