Fed rate hikes have made some corporate bonds very attractive. How to profit from it
As stocks sink and interest rates rise, investors are getting more excited about corporate bonds than they’ve been in a generation. One side effect of Federal Reserve tightening policy is it has made interest rates go up everywhere — including in the corporate bond market. But as pros point out, investors need to be careful and consider such things as credit risk and rate sensitivity as a recession could be looming. For that reason, bond investors are being steered toward the shorter duration bonds, those in the 2-year sector and lower, which have the highest yields in years but less risk than longer term bonds. They also favor higher quality over low quality high-yield or junk bonds. “If you look at investment grade yields at 5.4% or so, that’s a yield level that investors haven’t experienced since 2009, and obviously that was a very different spread environment than we’re in right now,” said Jonathan Duensing, head of U.S. fixed income at Amundi Asset Management. Bond prices fall as yields rise, so investors buying now could see their bonds go down in price if rates keep rising. But Duensing said the high yields now are serving as a cushion against that for investors in the shorter duration bonds. “Yields are high. If you’re talking about a two- to three-year investment horizon, the vast majority of these investment grade securities are actually going to mature,” he said. “If you invest in something with a 5% yield with 2 years to maturity, you’re going to be able to make that 5% return. There’s going to be some volatility in there, but the point is that yield can buffer you from some volatility in the near term.” Stick with quality Investors can make their own bond purchases of individual corporate debt in $1,000 increments, but strategists warn that in this uncertain time where there could be a recession, it is best to stay in the highest quality bonds. “What’s going on in the short-end of yield curve, there’s no doubt it has good value, and I think it will be a good investment,” said Gilbert Garcia, managing partner with Garcia Hamilton Associates. “Any corporate spread widening will probably be offset by Treasury yields declining, but I would stick to the high quality names.” Garcia said he likes names like IBM and Apple . IBM’s 2-year bond was yielding 4.71%, according to Tradeweb. It was rated A- by Standard and Poor’s and A3 by Moody’s. Apple’s 2-year bond, rated Aaa by Moody’s and AA+ by S & P, was yielding 4.29%, according to Tradeweb. Garcia said he is avoiding financials. “The financial themselves, the banks and brokers are widening. The corporate bond spread is probably going to widen, but when you’re that short the breakeven gives you a lot of room before you lose money,” Garcia said. Garcia said he also likes Aflac , Walt Disney, Deere and Caterpillar . According to Tradeweb, an Aflac 5-year was yielding 4.88%, while Deere’s 2-year was at 4.42% and Caterpillar’s 2-year was at 4.46%. Anthony Watson, founder of Thrive Retirement Specialists, said he advises clients of his Dearborn, Mich. firm to hold corporate bonds as one of nine asset classes. “We believe it makes sense to own this asset class. The way we choose to access corporate bonds is through a highly diversified low cost index fund and part of the reason for that is when it comes to corporate bonds, there’s more difficulty with them than with government bonds,” he said. Treasurys are impacted by the length of the maturity, while corporate bonds have credit risk and can be impacted by a credit downgrade for instance. Playing through funds A fund that tracks short-term corporates is the SPSB, SPDR Portfolio Short Term Corporate Bond ETF . Other short-term funds have seen declines, but they have outperformed the S & P 500’s more than 19% decline this year. The SPSB ETF tracks the Bloomberg 1-3 year Corporate Bond Index, and it is down 5.4% year-to-date. The short-term funds have also outperformed the popular iShares iBoxx $ Investment Grade Corporate Bond ETF LQD , which holds longer duration bonds and lost 22.3% so far this year. The weighted average maturity is 13.22 years, according to BlackRock. There is also the Vanguard Short-Term Corporate Bond ETF VCSH , which tracks a corporate bond index, is off 8.5% this year. The iShares 1-5 year Investment Grade Corporate Bond ETF IGSB is also off about the same. It tracks the ICE BofA 1-5 Year U.S. Corporate Index. There’s PIMCO Enhanced Short-Maturity Active ETF MINT, off 2.5% for the year. About half of the ETF is investment grade credits. It also holds securitized assets and other short duration instruments. Watson said he favors an ETF approach with multiple holdings because credit risk could be an issue. He said the Fed’s hawkish stance has the market concerned the central bank will drive the economy into recession. “What that means now is investors need to be rewarded more for taking that credit risk. If we’re going into recession, some companies are going to struggle,” he said. He added that the move in rates has changed the perception about bond investments which have had little yield for years. “I think there’s opportunity in the space for awhile. You have two different things going on. You have an economy that’s not hunky dory, that’s slowing and maybe heading into recession,” he said. “It will be highly dependent on the interest rate outlook for the Fed.”
