A New Spin On Corporate Bond ETFs

Even investment-grade corporate bonds and the corresponding exchange traded funds have been highlighted in some circles as vulnerable to rising interest rates and issuance of such bonds has slumped in recent months, but that combination of negative factors could actually spell opportunity.

So it is possible the newly minted FlexShares Credit-Scored US Long Corporate Bond Index Fund LKOR, which is a different spin on the prosaic investment-grade corporate bond ETF investors are used to, could be a well-timed idea. LKOR follows the Northern Trust Credit-Scored US Long Corporate Bond Index, “a newly developed credit index focused on U.S. long maturity corporate bonds,” according to FlexShares, a unit of Northern Trust NTRS.

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Advisors and investors have no shortage of investment-grade corporate bond ETFs from which to choose. In fact, the iShares iBoxx $ Investment Grade Corporate Bond ETF LQD is one of the largest fixed income ETFs of any stripe. What that means is that newcomers, such as LKOR, have to do something to standout and the new FlexShares offering has the potential to do just that.

LKOR's nearly 140 holdings are culled from “a liquid issuer universe, employs a proprietary model for credit scoring and then optimizes the index’s constituents to maximize the credit score while maintaining duration, spread and other characteristics similar to the long corporate bond universe,” according to FlexShares.

On the Standard & Poor's ratings scale, over 83 percent of LKOR's holdings are rated either A or BBB. Nearly two-thirds of the new ETF's holdings are issued by industrial, consumer or energy firms.

While LKOR's efforts to target high-quality issuers with low default risk and the potential for solid yields and capital appreciation are advantageous, interest rate risk cannot be overlooked. Over 93 percent of LKOR's holdings have maturities ranging from 15 to 20 years or 20 to 30 years, giving the new ETF a weighted average effective duration of 13.3 years, according to issuer data.

Still, LKOR's emphasis on liquid corporate bonds is a compelling trait at a time when so many market observers are concerned about corporate bond market liquidity. That issue has come about because post-financial crisis regulations have crimped banks' trading of corporates.

“Topping the list were the shortcomings of legacy fixed income market benchmarks. These market weighted indexes are increasingly seen as flawed and muddled representations of the bonds available to the typical investor. Next, tighter regulations and higher capital standards have reined in global banks` fixed income trading businesses, reducing overall liquidity in the bond market,” said FlexShares.

LKOR debuted last week alongside the FlexShares US Quality Large Cap Index Fund QLC.