Corporate Credit Quality Will Be Meaningful in 2023 | ETF Trends

After a rough year in 2022, corporate bonds are emerging as fixed income rebound ideas in 2023, but investors need to be judicious when it comes to evaluating both high-yield and investment-grade opportunities.

With a growing chorus of banks and economists forecasting the arrival of a recession at some point in 2023, some fixed income market observers are advocating that investors favor higher-quality corporates over junk-rated fare. Among the various exchange traded funds providing exposure to investment-grade corporate bonds, the VanEck Moody’s Analytics IG Corporate Bond ETF (MIG) could be a compelling 2023 idea.

MIG’s methodology underscores why it’s a relevant consideration for investors searching for income without taking on undue risk. The ETF focuses on investment-grade corporate bonds with appealing valuations that also sport lower odds of downgrades. The latter point is particularly important against the backdrop of looming economic contraction.

With economic growth expected to slow and recession risk still high, we suggest investors focus on higher-rated investments. Rather than reach for yield in the lower-rated parts of the market, we’d rather focus on those with investment-grade ratings and the relatively high (often 5% or higher) yields they tend to offer,” notes Collin Martin of Charles Schwab. “There may be better opportunities in 2023 within the riskier parts of the market —like sub-investment-grade, or ‘junk,’ bonds — but they are likely to see price declines before they get there, which would be painful for those holding these investments.”

MIG, which turned two years old earlier this month, answers the quality call as nearly 89% of its holdings carry investment-grade ratings. More than 31% of that group is rated AA or A, which implies downgrade risk in the fund is relatively benign.

MIG’s focus on investment-grade debt with reduced odds of downgrades is relevant for other reasons, including increasingly slack earnings growth and already sluggish corporate growth.

“If corporate profits remain stagnant or continue to decline, we believe high-yield issuers are more at risk than investment-grade issuers. High-yield issuers tend to have weaker balance sheets and more volatile cash flows, so when corporate profits slow, there’s little wiggle room for many issuers to remain current in servicing their liabilities. And as economic growth slows, the number of high-yield defaults should keep ticking higher,” concludes Schwab’s Martin.

MIG holds 223 bonds with an average maturity of 9.5 years, a tempting 30-day SEC yield of 5.47%, and an effective duration of 6.5 years, according to issuer data.

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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.