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Does FlexShares' New Corporate Bond ETF Stand Apart?

Zacks Equity Research

Corporate bond market has been hit by global growth concerns lowering the investor outlook on the credit worthiness of the corporations as well as looming interest rate hike. Further, there are concerns about corporate bond market liquidity (read: 3 Bond ETFs to Consider in a Market Slump).
In an attempt to take care of this situation and attract the investment grade corporate bond ETF investors, FlexShares – a unit of Northern Trust Corporation (NTRS) – has launched FlexShares Credit-Scored US Long Corporate Bond Index Fund. The ETF focuses on longer maturity corporate bonds and is trading under the symbol LKOR.
LKOR in Details
LKOR follows a recently developed Northern Trust Credit-Scored US Long Corporate Bond Index. As per FlexShares, the index covers a liquid issuer universe, employs a proprietary model for credit scoring and optimizes the index’s constituents to maximize the credit score while maintaining duration, spread and other investment grade-like characteristics.
More than 66% of LKOR’s holdings have maturities ranging from 20 to 30 years while more than 27% have maturities ranging from 15 to 20 years. This results in a weighted average effective duration of 13.25 years, as per the issuer.
The ETF comprises 136 holdings with Apple Inc. (AAPL) occupying the top position with 1.43% share, followed by Time Warner Inc. (TWX) with 1.34% share and JPMorgan Chase & Co. (JPM) with 1.29% share. The top 10 holdings constitute around 12.5% of the fund.
As far as sector allocation is concerned, Industrials (23.7%), Consumer (20.8%) and Energy (18.9%) make up the top three positions. Considering country-wise allocation, the fund is heavily biased towards the U.S. with 87.6% share while Canada, U.K., Netherlands, Australia and Spain hold minimal shares.
The fund is cheap as it charges only 22 bps in fees from investors per year (see all Investment Grade Corporate Bond ETFs here).
How Does it Fit in a Portfolio?
LKOR seems to have addressed the investors’ concern about the companies’ ability to repay their debt as economic slowdown in China and low commodity prices may lead corporations to face financial crisis. This is because the issuer has targeted corporate bonds with higher credit quality, lower risk of default and potential for higher yield and price appreciation. On the Standard & Poor’s ratings scale, the fund’s quality breakdown includes investment-grade ratings AAA (2%), AA (14.8%), A (36.6%) and BBB (46.6%).
Moreover, the fund seeks to improve liquidity and transparency by excluding illiquid and smaller issuers. The question of liquidity is of high importance as banks, serving as brokers, have reduced their inventories of corporate bonds following post-financial crisis regulations, making bond trading difficult (read: Is Carl Icahn Right about BlackRock and Bond ETFs?).
It is for these reasons the issuer has stated that the ETF provides “a contemporary approach to optimizing credit risk, with improved transparency and liquidity relative to legacy corporate bond benchmarks”.
ETF Competition
LKOR definitely stands apart from other long term corporate bond ETFs as it addresses the present ailments in the corporate bond market. Still, there are a number of such ETFs that worth to mention due to their popularity. A couple of long term corporate bond ETFs includes iShares iBoxx $ Invst Grade Crp Bond (LQD) and Vanguard Long-Term Corporate Bond ETF (VCLT).
LQD tracks the iBoxx $ Liquid Investment Grade Index focusing on 600 highly liquid investment grade corporate bonds in the U.S. It has an asset base of $22.1 billion and focuses on all-term bond duration.
On the other hand, VCLT follows the Barclays U.S. 10+ Year Corporate Index focusing on corporate bonds issued by industrial, utility, and financial companies, with over 10 years in maturities. It manages an asset base of $991 million.
Both LQD and VCLT look attractive on the cost front with expense ratios of 0.15% and 0.12%, respectively. However, in terms of yield, VCLT (4.14%) is a better option than LQD (3.13%).
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NORTHERN TRUST (NTRS): Free Stock Analysis Report
FLEXS-CS LCB (LKOR): ETF Research Reports
APPLE INC (AAPL): Free Stock Analysis Report
TIME WARNER INC (TWX): Free Stock Analysis Report
JPMORGAN CHASE (JPM): Free Stock Analysis Report
ISHARS-IBX IG (LQD): ETF Research Reports
VANGD-LT CRP B (VCLT): ETF Research Reports
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