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Investors Should Hold Higher Quality Corporate Bond ETFs

ETFtrends.com

After the recent sell-off in high-yield bonds, investors should take a second look at investment-grade corporate bond exchange traded funds as a more stable play for the fixed-income market.

Analysts at the Schwab Center for Financial Research argue that investors should be buying bonds from higher-rated companies, reports Mike Cherney for the Wall Street Journal.

Collin Martin, senior research analyst at Schwab, points out that investment-grade debt weathered the shocks in the fixed-income market when investors dumped junk bonds. He argues that the selloff revealed liquidity issues in the high-yield market where it was more difficult to buy and sell low-quality debt, compared to higher-rated securities.

For the month ended Aug. 1, iShares iBoxx $ High Yield Corporate Bond ETF (HYG) declined 2.9%. Meanwhile, the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) was up 0.3% and Vanguard Intermediate-Term Corporate Bond ETF (VCIT) was 0.2% higher.

“With high-yield bonds, we don’t think we’re going to see a big pickup in the default rate, but we do think at current levels, yields don’t really justify the risks involved,” Martin said in the article. “We’d wait for a better entry point in high yield, and for now we continue to focus on investment grade.”

According to Barclays data, high-yield, junk bonds have a yield of 5.25%, or a 3.65 percentage point spread over benchmark U.S. Treasuries. Junk bond yields were at 4.83% at the end of June, with a spread of 3.23 percentage points to Treasures. In comparison, investment-grade bonds, which are yielding 2.91% with a spread of 1.02 percentage points, remain largely unchanged from the end of June when yields were 2.92% with a spread of 0.97 percentage points.

LQD has a 3.05% 30-day SEC yield and VCIT has a 3.03% 30-day SEC yield. Meanwhile, HYG has a 4.79% 30-day SEC yield.

“We’ve been cautious in high yield for a while now, and we saw a little shakeout at the end of June and into July,” Martin added. “We think a lot of investors are most likely moving too low in quality to get just a slight pickup in yield.”

Investors can also gain exposure to investment-grade quality international debt through ETFs, including the PowerShares International Corporate Bond Portfolio (PICB) , which has a 1.66% 30-day SEC yield, and the SPDR Barclays International Corporate Bond ETF (IBND) , which has a 0.82% 30-day SEC yield.

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

Max Chen contributed to this article.

Full disclosure: Tom Lydon’s clients own shares of LQD and HYG.

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.