Short Considerations With Corporate Bond ETFs

Recent turbulence in equities made its way to the corporate bond space. Last week, spreads on the Morningstar Corporate Bond Index, an investment-grade corporate bond gauge, and the BofA Merrill Lynch High Yield Master Index, shot higher.

While traditional investment-grade and junk bond funds were hit hard amid last week's equity market sell-off, some short-term corporate bond exchange traded funds are proving to be better options in the early stages of 2018. The iShares iBoxx $ Investment Grade Corporate Bond ETF LQD, the largest corporate bond ETF, has an effective duration of 8.4 years.

“The greater the interest rate or credit risk an ETF takes on, the higher the expected return,” CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth said in a Tuesday note. “LQD has an average duration of 8.4 years, which contributes negatively to our overall rating but is offset by a variety of other factors, including the investment-grade quality of its holdings.”

Other Ideas

Investors looking to trim duration risk with corporate bond ETFs have some viable options to consider. For example, the $737.9-million iShares 0-5 Year Investment Grade Corporate Bond ETF SLQD holds over 1,100 corporate bonds, all with maturities of less than five years.

Relative to LQD, “SLQD has an average duration of just 2.3 years and charges an even lower expense ratio than LQD (0.06 percent vs. 0.15 percent),” said Rosenbluth. “At the end of January, SLQD had 42 percent of its $740 million in assets in bonds rated A or equivalent by major rating agencies and 40 percent rated BBB. Naturally, a smaller ETF like SLQD trades less frequently than LQD, but SLQD’s bid/ask spread was relatively tight at 2 cents. Year to date through Feb. 9, SLQD lost just 0.34 percent, a narrower decline than its iShares sibling.”

SLQD has a 30-day SEC yield of 2.56 percent.

Junk, Too

The SPDR Bloomberg Barclays Short Term High Yield Bond ETF SJNK is the shorter duration cousin to the popular SPDR Bloomberg Barclays High Yield Bond ETF JNK, the second-largest junk bond ETF.

SJNK “launched in 2012 and provides similar credit exposure as JNK (39 percent of its $4 billion of assets in both BB- and B-rated bonds), but with duration of just 2.2 years,” said Rosenbluth. “The lower interest rate risk helped to limit the downside in recent weeks, as SJNK’s total return was only down 0.32 percent. SJNK also trades less frequently than its longer-term peer, but has a tight 1-cent bid/ask spread to go along with its 0.40 percent expense ratio.”

CFRA has Overweight ratings on SLQD and SJNK.

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