Fixed income investors are undoubtedly hoping that the current consensus regarding the Federal Reserve not raising interest rates for the remainder of this year proves true. The July reading of the Consumer Price Index (CPI) appears to imply the central bank might just have that latitude.
Add to that, banks and economists are paring expectations that a recession will arrive later this year or even early in 2024. Put it all together and it appears that the current environment may be conducive to longer duration and high-yield bonds. Advisors and investors that don’t want to tempt fate might want to consider going the opposite direction while evaluating exchange traded funds such as the Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH).
Home to 2,468 bonds, VCSH follows the Bloomberg U.S. 1-5 Year Corporate Bond Index and is home to exclusively investment-grade corporate debt. That’s an attractive attribute at a time when some market observers are highlighting issues in the high-yield corner of the bond market.
”Global ratings performance data underscores the greater vulnerability of high-yield (HY) non-financial corporate issuers to weakening global economic growth, inflation, and rising rates than investment-grade credits (IG),” noted Fitch Ratings. “Downgrades have exceeded upgrades for Fitch-rated HY issuers since 3Q22 across most regions while upgrades have been more prevalent among our IG universe.”
VCSH Has Advantages
Regarding the specter of corporate debt downgrades and credit quality, VCSH stands out from the crowd as 53.50% of its holdings are rated AA or A. Strong credit quality like that might imply investors have to sacrifice income to access VCSH’s reduced risk profile, but that’s not the case as the Vanguard sported a 30-day SEC yield of 5.41% as of Aug. 8.
That can be viewed as a “best of both worlds” scenario for VCSH investors and one that’s a value add at a time when there’s concern about ratings agencies’ views on junk-rated corporate debt.
“The North American (NA), Asia Pacific (APAC), and Latin American (LATAM) regions all showed positive net rating actions for IG issuers and negative net actions for HY during 2Q23. Negative rating actions within HY have been decelerating for NA and APAC in recent quarters,” added Fitch.
In addition to robust credit quality, VCSH doesn’t subject investors to significant interest rate risk as highlighted by an average duration of just 2.7 years. That’s something to consider because it’s still possible the Fed deploys a rate hike or two before year-end.
For more news, information, and analysis, visit the Fixed Income Channel.