Investment Grade ETFs Could Help Hedge Against Inflation
Investment-grade bond exposure may be the answer as investors attempt to jointly tackle inflation and recession, experts say.
In the span of one year, as the Federal Reserve raised rates more than 400 basis points and recession fears continue, the relatively safer fixed income vehicles will play a more critical role in client portfolios.
As defaults are set to trend higher, and economic headwinds such as Russia’s invasion of Ukraine, put pressure on businesses’ ability to pay down debt, investment-grade ETFs offer a way to leverage higher returns in the coming months.
Speaking at the Exchange conference in Miami Beach, Florida, Balaji Venkataraman, American Century Investments client portfolio manager, noted how the central bank’s moves played a role in the dismal performance of bonds in 2022. Still, he noted investors may see increased value in fixed income vehicles this year as yields continue to rise.
“The rate risk has subsided meaningfully because the fixed income market tends to price in where the Fed is going well before the Fed gets there. And that’s why we’ve seen a decline in yields here today,” Venkataraman said.
He also noted that investment-grade bonds, which denote the debt of higher-grade securities, may be a key investment during periods of heightened inflation, as yields begin to decrease in response to the Federal Reserve easing rates. Bond prices rise as yields fall.
“The beauty of fixed income in this environment, if the Fed eventually does [come to] its peak in terms of the terminal rate, bond yields should probably continue to come down,” Venkataraman said.
The S&P 500 Investment Grade Corporate Bond Index has jumped 3.4% year to date. According to ETF.com data, one of the largest funds tracking investment-grade debt, the iShares iBoxx $ USD Investment Grade Corporate Bond ETF (LQD), has lured in $2.5 billion so far this year. Meanwhile, the IShares Broad USD Investment Grade Corporate Bond ETF (USIG) gained 4.34% in January, according to data from Morningstar Direct.
“When it came to bonds, a longer time horizon was deadly in 2022. But investors that stuck with these funds—or better yet, bought them at a discount—have started to receive the premium embedded in their yields,” Ryan Jackson, manager research analyst for Morningstar Research Services, wrote in a blog post.
Despite bonds seeing their worst year on record in 2022, fixed income ETFs emerged as a bright spot for the industry, as inflows for the asset class rose 8% from the previous year to $189 billion as investors wagered the investment vehicle would be a safer haven over equities.
The trend continued into this year, as bond funds picked up $20.8 billion in January, the most of any asset class in the month, according to ETF.com data.
Contact Shubham Saharan at shubham.saharan@etf.com
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