The current environment is trying for corporate bonds and the related exchange traded funds. With elevated concerns regarding a raft of potential downgrades for corporate debt hovering just above junk status, some bond investors are emphasizing fundamentals.

The WisdomTree Fundamental U.S. Corporate Bond Fund (CBOE: WFIG) is an ETF that can help with that objective. WFIG, which has an effective duration of just under seven years, tracks the WisdomTree Fundamental U.S. Corporate Bond Index (WFCIG). That benchmark focuses on quality companies with attractive income potential.

Factors investors should be paying particularly close attention with corporate bonds include interest and leverage coverage ratios.

“When leverage is deployed effectively, investors win. The total leverage ratio for the WisdomTree Fundamental U.S. Corporate Bond Index (WFCIG) is only 2.56x while the total leverage ratio for the market-cap index is 3.28x,” said WisdomTree in a recent note. “This is consistent for both the investment-grade universe as a whole and the BBBs within WFCIG. Notice the total leverage for BBBs in WFCIG is only 2.87x compared to 3.40x in the market-cap index. When examining leverage through other lenses such as net debt to EBITDA or debt to assets, similar patterns emerge.”

Why It’s Important

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.

Just over two-thirds of WFIG’s roster carries BBB ratings, but that does not mean the fund is endangered should a spate of downgrades ensue.

“In terms of interest coverage ratios, a common rule of thumb is for businesses in most industries to maintain a comfortable cushion of at least 3.5x EBIT to interest expense,” according to WisdomTree. “While market-cap-weighted approaches currently pass with coverage in excess of 5x, our fundamental approach sports a near 40% improvement in interest coverage ratios. In our view, this additional margin of safety puts these businesses on an even more stable footing should the economy decelerate over the next several years.”

For more on bond funds and strategies, please visit our Fixed Income Channel.

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