For much of this year, income-starved investors embraced investment-grade corporate bond exchange traded funds as part of their efforts to generate more income and add yield to their bond portfolios.
Enthusiasm for investment-grade corporates includes the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), the largest corporate bond ETF.
Fueling the increased demand for debt assets, tumbling yields on safer government and corporate debt pushed investors towar riskier and higher yielding debt, like junk bonds. Furthermore, U.S. corporate bonds are enjoying a stronger tailwind in an environment of strong economic growth, healthy earnings and dropping default rates.
LQD “is a solid option for market-cap-weighted exposure to U.S. dollar-denominated debt with more than three years remaining until maturity. This exclusion of short-term bonds gives the fund greater interest-rate risk than most of its actively managed peers in the corporate bond Morningstar Category,” according to Morningstar.
LQD, home to nearly $39 billion in assets under management, follows the Markit iBoxx USD Liquid Investment Grade Index and holds almost 1,900 corporate bonds. The ETF has a 30-day SEC yield of 3.31%, putting it well above 10-year Treasuries.
“Roughly one third of the portfolio is invested in the banking sector, which is a source of risk. The average sector exposure has been around 25% of the portfolio from 2009 to 2013, according to Morningstar data. “Any negative developments in this sector could hurt the performance. Its market-cap-weighting steered the fund toward A- and BBB-rated financial institution bonds. These bonds have low default risk, and offer a higher yield than Treasury securities with comparable terms.”
Over 88% of LQD’s holdings are rated either A or BBB. The ETF’s effective duration is 8.5 years. Duration measures a bond’s sensitivity to changes in interest rates.
“The portfolio’s exclusion of shorter-dated securities increases the fund’s interest-rate-risk,” according to Morningstar. “Its duration of 8.5 years, as of October 2017, was approximately two years longer than the category average. This duration implies that if the rate curve abruptly experiences a parallel shift by one percentage point, this fund could lose approximately 8.5% of its value.”
Investors have added $10.7 billion in new assets to LQD this year, good for the best total among all bond ETFs. Only five ETFs have larger 2017 inflows than LQD.
For more information on corporate debt, visit our corporate bonds category.
Tom Lydon’s clients own shares of LQD.