Look for Quality When It Comes to the Bond Market

The lowest of investment-grade bonds heading into junk status was one looming risk heading into 2020 before the capital markets were overcome with coronavirus fears. Now, as more investors pile into bonds, the fear is only exacerbating the flight to risk-off assets.

BBB bonds comprise almost 50% of the investment-grade bond market and a lack of liquidity could leave BBB bond investors holding the debt as it toes the line between investment grade and junk bond status–the worry, of course, being that it may eventually fall into the category of the latter.

“That supply would swamp the high yield market as it would double the size of the below investment grade bond market,” said Scott Minerd, global CIO at Guggenheim. “That alone would widen spreads even without the effect of increasing defaults.”

In the meantime, the equities fire sale continued during Wednesday’s trading session as the Dow Jones Industrial Average stumbled over 1,500 points.

“As for stocks, technical analysis suggests that there should be support around 2600 on the S&P 500, but in a recession scenario a level closer to 2000 could be the ultimate outcome,” Minerd said.

“Many skeptics have challenged this idea, saying that the panic is close to an end,” Minerd added. “In this circumstance, I recall the quote from Winston Churchill ‘This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.’”

ETF Options in Investment Grade Debt

Investment-grade corporate bond-focused fixed-income ETF options include the iShares Intermediate Credit Bond ETF (NASDAQ: CIU)iShares iBoxx $ Invmt Grade Corp Bd ETF (NYSEArca: LQD) and Vanguard Interm-Term Corp Bd ETF (NASDAQ: VCIT).

CIU tracks the investment results of the Bloomberg Barclays U.S. Intermediate Credit Bond Index. CIU focuses on investment-grade corporate debt and sovereign, supranational, local authority and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to ten years.

LQD seeks to track the investment results of the Markit iBoxx® USD Liquid Investment Grade Index composed of U.S. dollar-denominated, investment-grade corporate bonds. LQD allocates 95 percent of its total assets in investment-grade corporate bonds to mitigate credit risk.

VCIT seeks to track the performance of a market-weighted corporate bond index with an intermediate-term dollar-weighted average maturity, namely the Bloomberg Barclays U.S. 5-10 Year Corporate Bond Index. While VCIT holds debt issues with maturities between 5 and 10 years, they are all investment-grade holdings to minimize default risk.

For more trends in fixed income, visit the Fixed Income Channel.