Investment-grade corporate bonds haven’t escaped broader fixed income market turbulence, but the asset class could be among the leaders of a potential 2023 bond rebound.
With yields high and default risk still mostly benign regarding highly rated corporate debt, exchange traded funds such as the Vanguard Short-Term Corporate Bond ETF (VCSH) could be appealing for income investors looking to mitigate interest rate risk.
VCSH usually sports a dollar-weighted average maturity of one to five years, and its average duration is 2.7 years — low enough to ward off some of the rate risk inherent in rising rate environments. That utility is on display this year as the Vanguard ETF is beating the Bloomberg US Aggregate Bond Index by nearly 480 basis points.
Of course, VCSH lives up to Vanguard’s heritage of low costs. The ETF’s annual expense ratio is just 0.04%, or $4 on a $10,000 investment. That’s far below the category average.
“Since its 2009 inception, the fund has outperformed the category average by 90 basis points annualized. Much of this is due to its low fee and broad portfolio, as well as its relatively riskier credit quality profile. The fund was well-rewarded when credit spreads tightened, such as the recovery from the COVID-19 drawdown, and the first half of 2016. It outperformed the category average by 2.61 percentage points and 1.08 percentage points during those periods, respectively,” according to Morningstar.
That low fee is one reason that VCSH offered investors long-term outperformance against the broader short-term corporate bond category. Some naysayers will point to VCSH’s higher volatility relative to a broader short-term bond fund, but the fund’s pluses outweigh its minuses.
“Its absolute returns consistently outweigh the drawdowns, and its risk-adjusted performance, as measured by its Sharpe ratio, is still better than the category average. The fund’s riskier profile puts it in a better position to capture opportunities during risk-on markets while still remaining within the safe boundaries of the investment-grade space. It does not suffer significantly more when market gets rough,” added Morningstar.
VCSH currently yields 1.92%, which is better than what investors earn with broad equity benchmarks. Plus, the ETF has tailwinds entering 2023 that are supportive of a rebound.
“Credit > equity remains our preferred allocation heading into 2023. Investment grade bond yields are on par with S&P 500 forward earnings yield for the first time in 20 years, suggesting credit outperformance over the medium term,” according to Bank of America.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.