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Corporate Bond ETFs Aren’t Always Overweight Heavily Indebted Companies

This article was originally published on ETFTrends.com.

Like many equity-based exchange traded funds, traditional corporate bond ETFs use a cap-weighted methodology, but this does not mean that these funds are excessively allocated to heavily indebted companies.

The SPDR Bloomberg Barclays Corporate Bond ETF (CBND) targets the Bloomberg Barclays U.S. Corporate Bond Index, which is “is designed to measure the performance of the investment grade corporate bond market which includes publicly issued, investment grade, fixed-rate, taxable, U.S. dollar-denominated corporate bonds issued by U.S. and non-U.S. industrial, utility, and financial institutions,” according to State Street Global Advisors (SsgA).

CBND holds nearly 1,000 corporate bonds, so it may be understandable that some investors are concerned about the fund holding large amounts of debt issued by heavily indebted companies, but there is more to the story.

“Fixed income indices are rules-based and are designed to ensure investability by focusing on diversification and liquidity,” said SSgA in a recent note. “This means a fixed income index does not hold the entire sum of an issuer’s outstanding debt. Because issuers can raise various types of debt—such as short-term liabilities or financing denominated in a foreign currency—certain types of their debt may not qualify for inclusion in an index.”

CBND's holdings must have at least one year until maturity and at least $300 million par outstanding.

Tempting Yields

Nearly 90% of CBND's holdings are rated A or Baa. The fund's 30-day SEC yield is 4.22%. Temping yields and improved balance sheets at large U.S. companies are among the reasons why some financial advisors are favoring exchange traded funds that invest in investment grade corporate bonds.

Related: Broad Junk Bond ETF Tops $250M in Assets

Another point to consider is that simply because a company has taken on a lot of corporate debt, that does not mean the borrower will be strained to service that debt.

“If an issuer has a high level of debt, it doesn’t mean it cannot pay that debt, nor does it mean the company—or the fixed income ETF exposure—is at risk.” said SSgA. “Firms with a high amount of debt typically also have large asset bases and revenue profiles. If they didn’t, it’s unlikely the market would extend debt financing to these firms.”

CBND charges just 0.06% per year, or $6 on a $10,000 investment, making it one of the most cost-effective corporate bond strategies on the market.

For more information on the fixed-income market, visit our bond ETFs category.

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