Like other corners of the fixed income market, investment-grade corporates are taking their lumps this year at the hands of the Federal Reserve’s latest interest rate hiking campaign.
Year-to-date, the widely followed Markit iBoxx USD Liquid Investment Grade Index is down 17.09%. That’s far worse than the loss incurred by the Bloomberg US Aggregate Bond Index. Still, some experts believe that the time is right to revisit higher-quality corporate debt, and if that outlook proves accurate, it could benefit exchange traded funds such as the Franklin Liberty Investment Grade Corporate ETF (NYSEArca: FLCO).
One reason investors may want to look at FLCO over the near term is the point that investment-grade corporate bond yields are high by recent historical standards, meaning bond prices are low. The lower that a bond’s starting price is when an investor gets involved, the shorter the odds are of success.
“Corporate bond yields have risen along with U.S. Treasury yields, and then some. Corporate bond yields are composed of U.S. Treasury yields plus a spread meant to compensate investors for the additional risks that corporate bonds offer, like the risk of default,” noted Cooper Howard of Charles Schwab. “Investment-grade corporate bond spreads have risen along with Treasury yields, pulling the average corporate bond yield even higher. With this year’s rise, corporate bond yields are near their post-financial crisis highs.”
Another perk offered by FLCO is active management. While that doesn’t guarantee complete insolation from trying market environments, it can reduce downside risk. That much is on display this year as FLCO is topping the Markit iBoxx USD Liquid Investment Grade Index by nearly 200 basis points.
Additionally, actively managed ETFs such as FLCO can more nimbly take advantage of yield curve/slope opportunities, some of which are available today.
“The same can’t be said for U.S. Treasuries. When the yield curve is positively sloped, yields for longer-term bonds are higher than the yields for short-term bonds. After all, investors should be compensated with higher yields for taking on additional interest rate risk, but that’s not the case today with most Treasury yields,” added Howard. “Put differently, corporate bond investors are rewarded with higher yields when investing in intermediate- and long-term bonds. With U.S. Treasuries, yields decline from two years through 10 years.”
Another advantage of FLCO being actively managed is that the managers can identify strong income opportunities while minimizing credit risk — something to consider if a recession arrives.
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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.