Why LQD operates at a much higher risk to return ratio

Market Realist

Head-to-head: A comparative analysis of bond ETFs (Part 3 of 4)

(Continued from Part 2)

LQD is the iShares iBoxx ETF that tracks iBoxx Liquid Investment Grade Index consisting of 600 highly liquid investment grade corporate bonds. The price of the ETF as of February 14, 2014, was $116.22. The ETF’s price has varied between $108.47 and $119.34 over the past year. The table below captures the return for LQD and Corporate Bond Index, the bond index it tracks.

Holding this ETF has produced sequentially higher returns for the investors for the past five years, but returns dropped for the ten-year period. The ETF’s performance can be understood if reviewed against a benchmark index. In this case, we compare it against the Corporate Bond Index.

Time Period LQD Standard Deviation Bond Standard Deviation Average Treasury Rate LQD Sharpe Ratio Bond Sharpe Ratio
3 years 5.54 2.83 0.54 1.13 1.22
5 years 5.75 2.87 1.51 1.14 1.17
10 years 7.17 3.39 3.49 0.25 0.51

Standard deviation, the measure of risk or volatility of LQD, was the highest for the ten-year period. Comparing this against the Barclays Capital U.S. Aggregate Bond Index, we found that the ETF has been more volatile. In order to improve our measurement of return for the risk level, we calculated the Sharpe ratio (or SR) and found out that LQD and the bond index have similar SRs, although the bond would be the preferred investment option as its SRs were marginally higher. For the ten-year period, bond index would have been the better option, for it had the higher SR. The risk-free rates being used are three-year, five-year and ten-year Treasury yields. The beta of LQD is 0.32, which implies that if the Barclays U.S. AGG Bond Index moves by 1%, LQD moves by 0.32% in the same direction. So, LQD is less volatile than the bond index.

Continue to Part 4

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