How to be Careful With Corporate Bonds | ETF Trends

Not surprisingly, low interest rates are compelling corporate borrowers to refinance old bonds and issue new debt. New issuance isn’t a negative, but it does remind investors that quality is imperative in the corporate bond market.

The FlexShares Credit‐Scored US Corporate Bond Index Fund (NasdaqGM: SKOR) helps investors implement that factor at a time of surging corporate issuance.

In the investment-grade corporate bond market, a familiar concern is rearing its head early this year: the purported fragility of BBB-rated debt, an issue that grabbed plenty of headlines in 2019.

“The investment-grade portion of the corporate bond market (bonds rated at BBB- and better) has exploded from $800 billion in 2007 to $3.3 trillion today, according to Scott Minerd, global chief investment officer at Guggenheim Investments,” reports Nicholas Jasinski for Barron’s. “He is concerned that rapid growth in issuance has coincided with deteriorating quality.”

Sizing up SKOR

SKOR allocates 52% of its weight to BBB-rated debt, but that doesn’t mean the fund is chock full of bonds with that rating that are in danger of downgrades to junk territory. Corporate bond performance in 2020 could simply be a case of what goes up must eventually come down. With a banner year in 2019, it would be a difficult performance to duplicate in the new year.

Furthermore, an environment of easing by the Federal Reserve and a strong economy highlighted by low unemployment levels could be priced into this year’s gains. As Minerd notes in Barron’s, half the investment-grade universe is rated BBB today, up from just 35% in 2007.

“Minerd is worried that investors’ appetite for corporate bonds has been unfazed by that trend. Guggenheim expects up to 20% of BBB-rated bonds to be downgraded this year. That could see $660 billion worth of debt swamping the high-yield market,” according to Barron’s.

Related: With Corporate Debt Issuance Soaring, Focus on Quality 

The corporate bond market, including investment-grade issues, has recently been under some duress amid rising concerns about the tenuous grasps on investment-grade ratings held by some issuers. By some estimates, about half the U.S. investment-grade corporate bond market is rated BBB, meaning those bonds are one to three levels from junk territory.

The model that serves as a backstop for SKOR “also 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.”

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. 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.