ETFs and the corporate bond sector

Nick Sudbury assesses the merits of the corporate bond sector and looks at how the sector has grown in recent years

Investors nervous about the volatility of global equity markets and wary of possible sovereign debt defaults have sought more attractive risk adjusted returns by switching into corporate bonds. Morningstar calculates that in the year to 31 August the sector experienced an estimated net inflow of almost $10bn.

The post Lehman Brothers credit crisis of 2008 forced many large companies to deleverage and this has resulted in some strong balance sheets. Consequently investment grade corporate bonds now look like a better proposition than significant parts of the sovereign debt market.

There are only a dozen ETFs in the corporate bond sector that have been around for the last five years and all but one of them is up close to 50% or more over that period. The best performer is the Vanguard Long-Term Bond Index ETF (BLV) with a gain of 85.6%.

BLV tracks the Barclays Capital US Long Government/Credit Float Adjusted Index. This provides exposure to medium and larger issues of US government and investment-grade corporate dollar-denominated bonds that have maturities of more than 10 years.

Jeff Molitor, Vanguard’s chief investment officer for Europe, says that about 20% of the return is due to the weakness of sterling against the dollar. “A fund like this with a long duration does well when interest rates decline as they have done over the last few years.”



Solid option
Two of the other top performers also happen to be the largest ETFs in the sector. The Vanguard Total Bond Market ETF (BND) has AUM of more than £57bn and is up 64.8% over five years. It is followed by the Vanguard Short-Term Bond ETF (BSV) which has a market value of almost £14bn and a five-year return of 53.69%.

BND invests in more than 3,000 bonds that are representative of the broad, US investment-grade market. It currently has just over 70% in US government bonds and an overall yield to maturity of 2.3%. BSV is similar except that it invests in short rather than medium-dated maturities and has a yield of only 0.8%.

“The Fed’s Operation Twist involves buying more long-dated bonds to try to drive down longer term rates. If they are able to have an impact on the market it would be more likely to benefit ETFs like BND, although it is difficult to predict what will happen to rates overall,” notes Molitor.