Corporate bonds

With rates moving, shorten the duration of corporate bonds

In a rising rate environment, bond investors are caught between a rock and a hard place, but one solution is to add shorter-duration corporate bonds.

The Federal Reserve is already considering raising rates this year, which could erode bond incomes over time, especially if inflation continues to soar. Corporate bonds could be the sweet spot, offering investors an extra dose of yield to counter rising rates, while limiting the effect with a shorter duration.

“Based on Morningstar’s estimates that the U.S. economy will grow 3.9% this year and 3.5% next year, he thinks the current sweet spot – where investors can get the best return in exchange for price risk – are 5-year bonds on both the government and corporate side,” a CNN Business article reads.

Investors have recently been hit on both sides, stocks and bonds. For the latter, higher yields lower prices – hence the importance of limiting duration.

“The longer the maturity, the more price movement you’re going to have,” said David Sekera, chief US market strategist at Morningstar. “Maturity duration risk is the greatest risk for [bond] investors. »

Investors may need to take on more credit risk in order to earn a higher return, but Sekera also thinks corporate bonds will be stable as the economy continues to recover. That may not have been the case in 2020 when the pandemic first arrived in the United States and rattled bond markets.

“Between 5 years of government and corporate bonds, Sekera said he thinks companies — which pay more because they carry higher risk than Treasuries — will serve investors well,” the CNN article reads. “That’s because he expects corporate defaults to remain low and there will be more improvements than downgrades in corporate credit.”

Options for shorter duration corporate bonds

Vanguard offers options for different durations when it comes to gaining exposure to corporate bonds. One option is the Vanguard Short Term Corporate Bond ETF (VCSH).

The fund seeks to track the performance of a market-weighted corporate bond index with a dollar-weighted average short-term maturity. The fund uses an index investing approach designed to track the performance of the Bloomberg US 1-5 Year Corporate Bond Index.

This index includes taxable U.S. dollar-denominated, investment-grade, fixed-rate securities issued by industrial, utilities and financial companies, with maturities between one and five years. Under normal circumstances, at least 80% of the fund’s assets will be invested in bonds included in the index.

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