As with other segments of the fixed income market, high quality companies are feeling the brunt of the Federal Reserve’s latest interest rate hike this year.
Year-to-date, the widely followed Markit iBoxx USD Liquid Investment Grade Index is down 17.09%. This is much worse than the loss suffered by the Bloomberg US Aggregate Bond Index. Still, some experts believe now is a good time to revisit higher-quality corporate debt, and if that outlook holds true, it could benefit exchange-traded funds such as the Franklin Liberty Investment Grade Corporate ETFs (NYSEArca: FLCO).
One of the reasons investors might consider FLCO in the near term is the fact that investment grade corporate bond yields are high by recent historical standards, which means bond prices are low. The lower the starting price of a bond when an investor gets involved, the lower the chances of success.
“Corporate bond yields have risen along with US Treasury yields, and more. Corporate bond yields are made up of US Treasury yields plus a spread to compensate investors for the additional risk corporate bonds, such as the risk of default”, noted Cooper Howard by Charles Schwab. “Investment grade corporate bond spreads have risen along with Treasury yields, pushing the average corporate bond yield even higher. With this year’s rise, corporate bond yields are near their post-financial crisis highs.
Another advantage offered by FLCO is active management. Although this does not guarantee complete isolation from difficult market environments, it can reduce downside risk. This year, FLCO outperforms the Markit iBoxx USD Liquid Investment Grade Index by nearly 200 basis points.
Additionally, actively managed ETFs such as FLCO can take advantage of yield curve/slope opportunities more quickly, some of which are available today.
“The same cannot be said for US Treasuries. When the yield curve has a positive slope, longer-term bond yields are higher than short-term bond yields. After all, investors should be rewarded with higher yields for taking on additional interest rate risk, but that’s not the case today with most Treasury yields,” Howard added. “In other words, corporate bond investors are rewarded with higher yields when they invest in medium to long-term bonds. With US Treasuries, yields go down from two years to 10 years.
Another benefit of FLCO’s active management is that managers can identify strong revenue opportunities while minimizing credit risk – something to consider in a recession.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.