Get In The Middle With This Corporate Bond ETF

With U.S. interest rates low and poised to move even lower, income investors are scrambling for yield. Fortunately, the Federal Reserve is obliging, meaning investors can take some added interest rate risk.

What Happened

As the Fed raised rates four times last year, short duration bond funds, including those in the corporate bond space, were popular with income investors. Now, with the Fed easing, investors can consider more duration while accessing added yield with the likes of the Vanguard Intermediate-Term Corporate Bond ETF VCIT.

Home to $25 billion in assets under management and an expense ratio of 0.07%, the Vanguard Intermediate-Term Corporate Bond ETF is one of the largest and cheapest corporate bond ETFs on the market regardless of duration profile.

The average duration of VCIT's just over 1,800 holdings is 6.2 years, putting the Vanguard ETF firmly in intermediate-term territory.

Why It's Important

VCIT features a heavy dose (36.1%) of debt issued by financial services firms, a relic of the financial crisis when many banks sold debt to stay afloat and deal with bad loans. A near-term issue to consider with VCIT is how the market will treat BBB-rated bonds, those issues residing one to three notches above junk status.

“When credit spreads widen and the market requires greater compensation for bearing credit risk, which often happens in weakening business environments, lower-quality investment-grade corporate bonds tend to underperform safer Treasuries,” according to Morningstar. “Conversely, narrowing credit spreads give lower-quality bonds a boost. The lower the bond's credit quality, the more sensitive it is to changes in the credit spread.”

VCIT allocates almost 57% of its weight to BBB-rated bonds.

What's Next

There is compensation for the added risk associated with corporate bonds relative to Treasuries. For example, VCIT has a 30-day SEC yield of 3.42% compared to 2.21% on the iShares 7-10 Year Treasury Bond ETF IEF.

“The fund's cost advantage is its greatest appeal. It builds on its expense ratio advantage by mitigating transaction costs through its weighting approach, which favors the most-liquid bonds in the market that tend to be the cheapest to trade,” said Morningstar. “The fund also applies minimum liquidity requirements, which further reduces transaction costs and makes the index easier to track.”

The research firm has a Silver rating on VCIT.

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