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Quality Is Key For Corporate Bond Market

This article was originally published on ETFTrends.com.

At the start of this year, fears ran high that corporate bonds in the BBB-rated spectrum, meaning debt one to three notches above junk territory, were headed for a slew of downgrades. That scenario hasn't materialized as of yet, but market participants are again growing concerned about the fate of BBB corporates.

Investors can allay some of those fears with the FlexShares Credit‐Scored US Corporate Bond Index Fund (SKOR). SKOR is not the run of the mill corporate bond ETF. The ETF tracks the Northern Trust Credit-Scored US Corporate Bond Index, which focuses on issues from companies with quality characteristics such as strength in management efficiency, profitability, and solvency, according to FlexShares.

SKOR holds 357 corporate bonds and has a 30-day SEC yield of 2.51%. The fund is up nearly 8% year-to-date and resides near all-time highs. The ETF moves beyond relying solely on traditional corporate bond ratings as a metric of quality.

“The BBBs make up more than half of the investment-grade bond market—about 60% excluding banks, according to the bank. They add up to more than $3 trillion of bonds, while the entire U.S. high-yield bond market is worth around $1.2 trillion,” reports Alexandra Scaggs for Barron's.

Maintaining Strategy

Bond funds hold a collection of debt with varying maturities, buying and selling debt securities to maintain their short-, intermediate- or long-term strategy. When it comes to bond ETFs, investors should look at the duration, or a bond fund’s measure of sensitivity to gauge their investment’s exposure to changes in interest rates – a higher duration means higher sensitivity to shifts in rates.

SKOR’s underlying index only includes issues with at least $500 million outstanding. SKOR intentionally excludes smaller, illiquid issues to enhance its liquidity and transparency profile.

Related: A Smart Way to Build Out a Bond ETF Portfolio 

“The fear is that a wave of BBBs will get downgraded to junk in a recession and that those companies’ bonds will flood the high-yield market and drive prices lower across the market,” according to Barron's. “Even worse, that market pressure could drive up borrowing costs for the very riskiest companies, making them more likely to default.”

SKOR can ameliorate some of those issues because in building the roster, “multiple factors are taken into account including the characteristics of issuers’ total debt structure, minimum exposure percentages, and odd-lot trade restrictions, to aid in developing our corporate bond indexes,” notes FlexShares.

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

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