In my last Blog post, I discussed how the search for income in a low interest rate environment sparked flows into high yield bonds, and how this segment has seen a sell-off in recent months. Looking at the corporate bond market over the past few years, we see that there has been a growing demand for both investment grade and high yield corporate bonds. This rise in demand has been met by a substantial increase in the size of the corporate bond market.
Corporate Debt Offerings on the Rise
As my colleague Russ Koesterich mentions in a recent Blog post, deleveraging has taken place in the financial sector, but other segments have continued to grow and issue more debt. Over the past six quarters, corporate debt has been growing at an average annualized rate of around 9.5%, which exceeds the pre-financial crisis average of 7.5%. The U.S. investment grade credit bond market is now $5 trillion, with double the number of bonds available on the market from 10 years ago. Similarly, the high yield bond market is around $1.3 trillion, with 1.3 times more bonds over the same period, as illustrated below. More offerings in this space provide greater opportunities for investors to create diversified portfolios and get access to bonds across a range of sectors and credit qualities.
Source: Bloomberg as of 8/11/14
To take advantage of the low interest rate environment, corporations have not just been issuing more bonds, but longer maturity bonds as well, allowing them to lock in low rates of funding for extended periods. As a result, the weighted average duration of new investment grade issues has been 7.71 this year compared to 6.38 last year.
Turning to ETFs
Investors seeking exposure to investment grade or high yield corporate debt have increasingly been using fixed income ETFs, allowing them to get precise exposure to specific segments of the corporate bond market while gaining diversification. The over-the-counter nature of the bond market can make it difficult for most investors to build diversified portfolios, and ETFs can provide a more efficient way to transact. Here are several ways to play the corporate fixed income ETF space in your portfolio. As you can see, these segments have been growing along with the broader corporate bond market:
- For exposure to investment grade corporate debt, we like the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), which has grown by $2.55 billion over the past 3 years.
- For short-term U.S. investment grade corporate and non-corporate debt, the iShares 1-3 Year Credit Bond ETF (CSJ) is a potential solution. This was an especially popular investment in 2013 when fears of rising interest rates were top of mind for many investors. Over the past three years, investors have added $3.2 billion to the fund.
- Those seeking shorter term investment grade bonds whose coupons adjust to changes in interest rates may want to look at the iShares Floating Rate Bond ETF (FLOT), which has seen $4 billion of inflows since August 2011.
- For U.S. high yield corporate bond exposure, a potential solution is the iShares iBoxx $ High Yield Corporate Bond ETF (HYG). Despite the recent sell-off we have still seen over $2.9 billion come into this fund over a three-year period.
So is the recent growth in corporate bond borrowing a good thing? As Russ points out, it is a sign of increased borrowing and leverage in the economy, and if left unchecked, it could lead to financial challenges down the road. That said, for now the increased supply is serving to help meet investors’ need for income, while the ETF provides a diversified source of income that is designed to trade like a stock. No matter what comes next, diversification and access to liquidity are definitely key in helping you stay on top of your investments.
Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses, which may be obtained by visiting the iShares ETF and BlackRock Mutual Fund prospectus pages. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
Fixed income risks include interest-rate and credit risk. Typically, when interest rates rise, there is a corresponding decline in bond values. Credit risk refers to the possibility that the bond issuer will not be able to make principal and interest payments. Non-investment-grade debt securities (high-yield/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher-rated securities.
Securities with floating or variable interest rates may decline in value if their coupon rates do not keep pace with comparable market interest rates. The Fund’s income may decline when interest rates fall because most of the debt instruments held by the Fund will have floating or variable rates.
Diversification and asset allocation may not protect against market risk or loss of principal.
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