A Corporate Bond ETF For Conservative ETFs

Investment-grade corporate bonds and related exchange traded funds are options to consider for fixed income investors looking for higher yields and potentially better total returns than what's offered by Treasuries and traditional diversified bond funds.

The Vanguard Intermediate-Term Corporate Bond ETF VCIT is a cost-effective avenue for accessing investment-grade corporate debt. VCIT's annual expense ratio is just 0.07 percent, or $7 on a $10,000 position, making it cheaper than 91 percent of rival funds, according to Vanguard data.

“This exchange-traded fund provides market-cap-weighted exposure to investment-grade U.S. corporate bonds with between five and 10 years until maturity,” said Morningstar in a Wednesday note.

“It is one of the lowest-cost options in the corporate-bond Morningstar Category and has tightly tracked the Bloomberg Barclays U.S. 5-10 Year Corporate Bond Index. While there's plenty to like here, it's important to note that this fund has heavy exposure to the financial services sector, which could be a source of risk. It earns a Morningstar analyst rating of Silver.”

What Happened

Last year, investors added $8.06 billion to VCIT, good for one of the best asset-gathering tallies among all fixed-income ETFs. The inflow came even as the Federal Reserve boosted interest rates three times. The Fed raised interest rates in March, but VCIT has seen nearly $410 million in year-to-date inflows.

VCIT is down more than 4 percent year-to-date, pushing its yield to 3.34 percent — a healthy margin above 10-year Treasuries.

Why It's Important

VCIT has an average duration of 6.4 years and an average effective maturity of 7.5 years. Over 92 percent of the fund's nearly 1,750 holdings are rated A or Baa. Additionally, the ETF's exposure to bonds issued by financial services companies is rising.

“Roughly one-third of the portfolio is invested in the financials sector. Its average sector exposure was less than one-fourth of the portfolio from 2010 to 2016, according to Morningstar data. Any negative developments in this sector could hurt the fund's performance,” the research firm said.

“This concentration is mostly driven by large U.S. banks, which have issued a record amount of debt since 2010 to take advantage of low rates and meet the strict post-crisis capital requirements.”

What's Next

Further interest rate hikes, which are expected, could prompt bond investors to depart high-yield corporate debt. Some of those investors could transition to investment-grade fare such as VCIT. The key is VCIT's ability to endure rate hikes — and how high Treasury yields move.

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