Make The Corporate Call With This ETF

This year, a popular response to rising interest rates sees investors moving to short-term bonds and the related exchange-traded funds. Focusing on mitigating duration risk can cause investors to miss out on credit opportunities available via corporate bonds.

The WisdomTree Fundamental U.S. Short-Term Corporate Bond Fund SFIG can help investors with the lower duration/income-seeking conundrum.

What Happened

Investment-grade corporate bonds are facing some challenges as highlighted by a year-to-date decline of about 3 percent by the Markit iBoxx USD Liquid Investment Grade Index. Some market observers believe increasing supply and the upcoming mid-term elections, among other factors, are hindering investment-grade corporates.

“With the majority of benchmark IG issuance occurring in the 10- and 30-year sector, it’s likely that credit spreads will need to widen to absorb this new supply,” said WisdomTree in a recent note. “However, at the short end of the curve, spreads tend to be much more driven by economic fundamentals. For this reason, we believe that investors concerned about the relationship between credit spreads and issuance should bias their portfolio to the shorter end.”

Why It's Important

SFIG holds 111 corporate bonds with an effective duration of just 2.36 years. While most corporate bonds benchmarks weight components by issue size (cap-weighting) SFIG's underlying index takes a different approach.

The WisdomTree Fundamental U.S. Short-term Corporate Bond Index “employs a multi-step process, which screens on fundamentals to identify bonds with favorable characteristics and then tilts to those which offer attractive income characteristics,” according to WisdomTree.

Nearly 37 percent of SFIG's holdings are rated A and another 56.77 percent are rated BBB, indicating a tilt toward the lower end of the investment-grade spectrum, but investors are compensated for that albeit muted risk with a 30-day SEC yield of 3.04 percent.

What's Next

As the credit cycle ages, investors are expressing concerns about corporate leverage. SFIG's fundamentally-weighted methodology can minimize some of those leverage fears.

“While a market cap-weighted approach owns every bond regardless of its fundamentals, in WisdomTree’s approach, we seek to eliminate the bottom 20% of issuers based on leverage, return on invested capital (a measure of profitability) and free cash flow over debt service (a measure of debt sustainability),” according to WisdomTree.

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