Group Co.
The Case for Investment Grade Bonds
Traders Magazine Online News, August 22, 2018
Investors are demonstrating caution midway through 2018 by taking steps to help insulate their portfolios. That’s understandable on the heels of a nine-year bull market in U.S. stocks, given renewed volatility, uncertainty surrounding global trade policies and steadily rising interest rates.
Rather than sit idle in cash, investment grade corporate bonds may offer a mix of stability and income to investors seeking to navigate the current market environment. Investment grade corporate bonds represent something of a middle ground for investors between riskier equities and perceived safe haven assets like Treasury bonds.
For one thing, investment grade corporate bonds are generally less volatile than the broad equity market. Over the past three years, the total return volatility for U.S. investment grade corporate bonds has been roughly 3.4%, compared with total return volatility near 10% for U.S. stocks.[1]
Investment grade bonds are typically issued by high-quality corporations, those with credit ratings between AAA to BBB-. Since corporate bonds carry credit risk, or the potential for default, they tend to offer a higher yield than similar maturity government bonds.
A sweet spot for yields
With the U.S. economy on surer footing, the Federal Reserve has ratcheted up its target short-term interest rate three times over the past year. Markets are pricing in at least one more increase before the end of 2018.
In turn, investors are demanding higher yields on corporate bonds. Longer-maturity investment grade corporate bond yields have increased between 0.4% and 0.8% over the past year, as the chart shows; short-term corporate bond yields are up more than 1.25% in yield over the past year.[2]
Corporate suite
Using corporate bond ETFs to manage investment goals
Investors should think about their investment goals and time horizon when weighing the merits of investment grade corporate bonds. Dividing the corporate bond yield curve into distinct maturity segments, such as 1-5 years or 5-10 years, allows investors to target specific corporate bond maturity profiles depending on their needs, risk tolerance and investing horizons. Exchange traded funds (ETFs) allow investors to assemble customized investment grade corporate bond portfolios.
How to think about bond maturity ranges:
1 to 5 years: This range may suit investors who want to reduce vulnerability to the risk of rising interest rates. With corporate bond index yields in this maturity range currently hovering over 3%[5], investor cash flows may help keep pace with inflation, which in June rose 2.9% from a year earlier.[6] This is good news for savers who seek to preserve the purchasing power.
5 to 10 years: This range may reward investors with higher yields but comes with incrementally higher interest rate risk. Known as the “belly” of the yield curve, the 5-10 year maturity range generally offers higher income with an intermediate duration of about 7 years.
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