A Corporate Bond ETF Helping Investors Avoid Potential Downgrade

The corporate bond market is being pinched by the coronavirus pandemic and recession fears. Some investors are departing investment-grade corporate bond funds at a rapid pace while the dollar amount of what were once high-grade corporates being downgraded to junk status is ballooning.

Investors can avoid corporate debt trouble spots while still maintaining a decent level of income with ETFs, such as the WisdomTree Fundamental U.S. Corporate Bond Fund (CBOE: WFIG).

WFIG tracks the WisdomTree Fundamental U.S. Corporate Bond Index (WFCIG). That benchmark focuses on quality companies with attractive income potential. The benchmark’s methodology overtly dodges bonds that could become fallen angels – those going to junk from investment-grade.

“Here at WisdomTree, our approach emphasizes the potential to avoid ‘fallen angel candidates’ (investment-grade issuers that are downgraded to high yield) by focusing on the fundamentals,” said the issuer in a recent note. “The WisdomTree Issuer Fundamental Scores effectively quantify the balance sheet strength of corporate bond issuers. Without a strong balance sheet, companies may have difficulty servicing their debt and ultimately end up getting downgraded to junk status. We use three metrics to screen our universe of investment-grade corporate bonds: free cash flow to debt service, total debt to assets and return on invested capital. We remove those which screen poorly on these fundamentals.”

Good Time For WFIG

A growing concern in the corporate bond universe is the massive amount of BBB-rated debt that could be vulnerable to downgrades to junk status in the months ahead. Currently, a significant percentage of the U.S. corporate bond market has a BBB rating of some kind, meaning those bonds are within one to three notches of junk status.

WFIG’s underlying index “offers an intuitive approach, seeking to identify debt issues with quality fundamentals and attractive income profiles. The table below illustrates the construction of WFCIG, how the Index is impacted by removing the bottom 20% of issuers with poor fundamentals, and how we believe weighting bonds by our income score boosted the yield profile of the Index,” according to WisdomTree.

WFIG’s fundamental focus helps it avoid risky investment-grade bonds that are vulnerable for downgrades to junk status, such as the recently downgraded Kraft Heinz Co. (NASDAQ: KHC) and others that could be vulnerable to near-term downgrades, such as energy companies and weak industrial names,

“The WisdomTree U.S. Corporate Bond Fund (WFIG), which is designed to track the aforementioned WFCIG, offers investors the potential to avoid the pitfalls of corporate bond investing that seem to be getting highlighted on a daily basis in the current environment,” according to the issuer.

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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.