Amid expectations that the Federal Reserve will lower interest rates this year, perhaps multiple times, there’s optimism that corporate bonds and the related exchange traded funds could be in for another round of solid annual performances.
Encouraging as that may be, advisors and investors still need to exercise discretion in the corporate bond universe. Data indicates default rates are ticking higher. That could be a sign that risks linger in the high-yield corporate bond space. Market participants can limit those risks while maintaining stout income profiles with the VanEck Moody’s Analytics IG Corporate Bond ETF (MIG).
MIG, which turned three years old last month, focuses on investment-grade corporate debt. That implies its risk profile is reduced relative to dedicated junk bond ETFs. However, that doesn’t mean investors sacrifice income with the fund as highlighted by its 30-day SEC yield of 5.19%.
MIG Relevant in Current Bond Environment
Among MIG’s sources of allure is its index methodology. One of the primary objectives of the MVIS® Moody’s Analytics® US Investment Grade Corporate Bond Index is to identify investment-grade corporate bonds with reduced probabilities of being downgraded to high yield.
In any environment, that’s a trait objective risk-averse income investors will appreciate. But the benefits of that methodology are amplified at a time when some analysts see more strain in the junk bond space. At the end of last year, default rates for domestic junk bonds rose to 2.99% from 1.35% at the conclusion of 2021.
“In the US, Fitch forecasts 2024 default rates of 3.5%-4.0% for leveraged loans, and 5.0%-5.5% for U.S. HY. The higher default rate expectations for 2024 reflect ongoing macroeconomic headwinds. Including the impact of still high interest rates and a slowdown in the U.S. economy in 2024 relative to 2023. However, Fitch does not forecast a recession for the U.S. in 2024,” noted Fitch Ratings.
Among the sectors most at risk for defaults in 2024, Fitch lists healthcare, technology, and telecom as potential culprits. MIG features modest exposure to bonds issued by healthcare and telecom firms and while the ETF devotes almost 20% of its roster to tech-rated corporates, it’s worth remembering over 91% of the bonds held by MIG already carry investment-grade ratings, indicating those issues aren’t in ratings agencies’ crosshairs for big downgrades.
“Fitch expects the high interest rate environment will ease only moderately in 2024. And expects defaults to be driven by sector-specific issues in the healthcare and pharmaceutical, telecom, and technology sectors in the U.S.,” concluded the research firm.
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