With U.S. interest rates hovering near historic lows and borrowing costs tumbling around the world, fixed income investors face challenges, including locating adequate income without taking on significant risk.
The FlexShares Credit‐Scored US Long Corporate Bond Index Fund (CBOE: LKOR) is a prime example of a fixed income ETF that helps investors deal with the challenges of the current bond market.
“Historically, investors have allocated to fixed income to meet any of three key objectives: capital appreciation, income generation, and preservation of principal,” said BlackRock in a recent note. “Fixed income’s typical ability to provide ballast against equity sell-offs rests in the normal response of lower interest rates to falling stocks—resulting in a general negative correlation between bonds and stocks. When stock prices fall, bonds prices tend to rise. However, in recent years, super low, zero and even negative interest rates have driven up the value of fixed income securities limiting further capital appreciation and calling into question the asset class’s ability to diversify against future equity drawdowns.”
LKOR excludes illiquid and smaller issuers to improve liquidity and transparency. Additionally, the fund targets company bonds that have a higher credit quality, lower risk of default and potential for higher yield and price appreciation. LKOR holds 219 bonds with a weighted average maturity of 14.77 years, according to issuer data.
Looking Into LKOR
LKOR follows the Northern Trust Credit-Scored US Long Corporate Bond Index, which addresses potential corporate bond liquidity challenges by optimizing a carefully selected subset of all credit issuers from which illiquid, orphaned and small lot names have been removed,” said FlexShares. “Then, multiple factors are taken into account including the characteristics of issuers’ total debt structure, minimum exposure percentages, and odd-lot trade restrictions, to aid in developing our corporate bond indexes.”
LKOR is worth considering because with interest rates already so low, the Fed has little room for further cuts, meaning upside on government debt is potentially limited going forward.
“This implies simply less room for rates to fall when the Fed needs to again provide future accommodation,” notes BlackRock. “With zero as the effective lower bound, potential rate declines from here stand clearly lower than in past recessionary periods, implying less potential for positive fixed income returns to offset negative equity returns. So, bond ballast likely remains, but the ZLB limits its amount. In such an environment, alternative forms of ballast take on even greater importance.”
LKOR, which yields 3.46%, is up almost 11% in the second quarter.
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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.