More Could be Merrier for Corporate Credit Quality | ETF Trends

August was a brisk month in terms of corporate bond issuance and while it may seem counter-intuitive, all that new issuance could actually boost credit quality, potentially helping ETFs, such as the FlexShares Credit‐Scored US Corporate Bond Index Fund (NasdaqGM: SKOR), along the way.

SKOR tracks the Northern Trust Credit-Scored US Corporate Bond Index, which focuses on issues from companies with quality characteristics such as strength in management efficiency, profitability, and solvency, according to FlexShares.

“In terms of US$-denominated supply, corporate bond issuance attained record highs for the month of August,” notes Moody’s Investors Service. “More specifically, August 2020’s corporate bond issuance rose to record highs of $156 billion for investment-grade and $56 billion for high-yield. The former highs for the month of August were 2016’s $121 billion for investment-grade and 2012’s $33 billion for high-yield.”

SKOR Matters in this Climate

SKOR’s scoring methodology indicates the fund is appropriate for a broad swath of investors, including those looking to reduce risk.

“The FlexShares Credit Scoring Model addresses the corporate bond liquidity challenge by optimizing a carefully selected subset of all credit issuers of which illiquid, orphaned and small lot names have been removed,” according to FlexShares. “The model also takes into account multiple factors to aid in developing improved corporate bond indexes, including the characteristics of issuers’ total debt structure, minimum exposure percentages, and odd-lot trade restrictions.”

“In all likelihood, the latest surge in corporate bond issuance will not increase interest expense by enough to rein in future spending by U.S. companies. The National Income Product Accounts provide a rough estimate of net interest expense for U.S. corporations,” according to Moody’s.

Bond funds hold a collection of debt with varying maturities, buying and selling debt securities to maintain their short-, intermediate- or long-term strategy. When it comes to bond ETFs, investors should look at the duration, or a bond fund’s measure of sensitivity to gauge their investment’s exposure to changes in interest rates – a higher duration means higher sensitivity to shifts in rates.

As the Federal Reserve poured funds into the bond markets, particularly exchange-traded funds (ETFs) and individual bonds, it was corporate bonds that were the major beneficiary during the second quarter.

A one-two combination of tighter credit spreads and the central bank keeping rates low allowed companies to refinance current debt at lower rates or take on more debt.

For more on multi-asset strategies, please visit our Multi-Asset Channel.

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.