By Rob Isbitts
There are at least three major “calling bottom too soon” situations occurring as 2022 enters the holiday season. Stocks have been under water all year, but investors continue to focus on when the Fed will “pivot.” Gold bugs are still waiting for this rally. And then there are corporate bonds.
iShares 5-10 Year Investment Grade Corp Bd ETF (NASDAQ: IGIB) represents the best and worst of what’s both intriguing and frustrating about this class of ETFs right now. Ultimately, I come out on the side of “too risky, too soon”.
The IGIB is not a fancy approach to this currently depressed sector of the financial markets. It is managed by BlackRock’s giant iShares ETF group, has nearly $10 billion in assets and holds more than 2,000 securities. It is practically a corporate bond index itself. IGIB focuses on the 5-10 year maturity segment and aims to track the ICE® BofA® 5-10 Year US Corporate Index.
Exclusive ETF Ratings
Segment: Bonds and cash equivalents
Sub-segment: Corporate Bonds
Correlation (vs. S&P 500): Low
Expected volatility (vs. S&P 500): Moderate
A few key statistics help summarize IGIB’s current portfolio. 54% of its bond holdings are rated BBB, which is the lowest level of “investment grade”. Another 39% is allocated to the A-rated bond category. The fund’s yield to maturity is just over 6%, but its weighted average coupon is only around 3.5%. More on this later in this report. Predictably, he limits his holdings primarily to bonds maturing in the next 5-10 years. Around 76% of holdings are made up of bonds issued by US-based companies, with the remainder spread across Europe (16%) and, to a lesser extent, Asia (8%).
This is an adequate ETF from an iconic fund company, if you’re looking for a way to add exposure to A and BBB bonds to your portfolio. As shown here, the IGIB’s focus on corporate bonds has consistently outperformed the returns of the “Agg” bond index, which is a mix of high quality corporate and US Treasury securities. In other words, when the wind is at its back, the IGIB does what it needs to do, adding alpha by holding bonds that are less creditworthy than securities issued by the US government.
But as mentioned earlier and in the title of this article, there is a lot of “baggage” that IGIB and its corporate bond brethren have to contend with in the current era of investing. One of the biggest misconceptions about corporate bond funds is that they are primarily yield-seeking instruments. After four decades of falling interest rates, during which corporate bonds have accrued an enviable reward for risk taken, attitudes toward bond investing are changing. 2022 has made a generation of investors realize that bond prices can also drop sharply, and it can take years of interest payments to offset that. This makes bonds a very risky business until rates stabilize and credit market risk is reduced. Neither is happening now, at least not with any lasting effect.
While my general concern is that corporate bonds will remain a low risk-reward trade-off for some time to come, there’s a growing chance that the steep decline in corporates is approaching a buy at least to very long term. To be clear, it’s like improving the odds of making a half-court shot in basketball, instead of a full-court shot. My concern is that many retirees and pre-retirees will assume that the 2022 decline has made businesses a layup.
There are many threats to holding corporate bonds in this part of the bond cycle. Although they are higher in capital structure than in stocks, the fact is that there are plenty of BBB-rated bonds that should probably be in the junk category. The Fed has been buying companies in recent years, and with corporate profits likely to plunge in 2023, the combination of weaker corporate cash flows and the preponderance of corporate bond issuance hanging by a thread at this BBB rating, implosion is more likely than some large, lasting opportunity to “buy the dip”.
The other concern is, again, potential misperception. IGIB’s performance looks attractive. But that’s not what you get in cash flow. The average coupon is less than 4%, and this is reflected in the fact that the average bond price in the portfolio is hovering around 88 cents on the dollar at the time of writing. Translation: this ETF is more about price appreciation than a magically high cash return. So don’t confuse the first with the second.
Exclusive technical evaluations
Short-term rating (next 3 months): Hold
Long-term rating (next 12 months): Sell
ETF Quality Opinion
As described above, this ETF is what it says. iShares ETFs are solid from a business perspective. But that’s a much smaller problem than what the ETF has. This one holds corporate bonds, and despite the apparent low price of this asset class, I’m still not sold, beyond a trading/tactical opportunity.
ETF Investment Notice
We rate the IGIB as an expectation, but only because it is “dragging” near its lows for the year. Another price breakdown due to Fed hikes, credit-breaking activity, or both would immediately make this one avoidable.