Investment Grade Bonds Attractive

By Matthew McCall | November 02, 2011 AAA

The cash levels at large U.S. corporations continue to increase as many of them sit on the hordes of dollars. The cause of the cash levels rising, to their highest level in decades, could be based on several factors. One factor is the uncertainty surrounding the global economy, and therefore companies are more comfortable accumulating cash versus investing it in new capital projects or hiring. Another could be government regulation on industries, such as the financials where they are forced to increase capital and their cash balances. Whatever the reason may be, corporations are sitting on large amounts of cash, and it has resulted in strong balance sheets. This is just one reason I am a big fan of corporate bonds heading into next year. The large amounts of cash on the balance sheets of U.S. companies decreases the risk of default, and makes corporate bonds one of the safest investment vehicles available. Here are a few choices.

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Investment Grade
The largest corporate bond exchange-traded fund (ETF) is the iShares iBoxx Investment Grade Corporate Bond ETF (ARCA:LQD), with over $16 billion in assets. A recent rally has the ETF at the best level in 8 years, as investors have been searching out yield and low volatility. The ETF has an average maturity of 12.14 years as it is composed of a mix of short-term and long-term corporate bonds. It is also important to note that the bonds in the ETF are all considered investment grade by the rating agencies. Year-to-date, the ETF is up 6%, easily beating the S&P 500, and the current yield is 4.0%. The ETF is composed of 713 individual bonds, and it charges an annual expense ratio of 0.15%.

Investors in search of less volatility, but want to gain exposure to the corporate bond sector, could consider the iShares 1-3 Year Credit Bond (ARCA:CSJ). The ETF invests in fixed income that has maturities between one and three years. The average maturity is 1.90 years. The ETF is up less than 0.5% on the year, and the current yield is 1.5%. Due to the short maturities, the result is less volatility and a lower yield. The expense ratio remains low at 0.20%, and there are 683 bonds in the allocation.

Vanguard offers three corporate bond ETFs that vary based on maturity: Vanguard Short-Term Corporate Bond ETF (Nasdaq:VCSH), Vanguard Intermediate-Term Corporate Bond ETF (Nasdaq:VCIT) and Vanguard Long-Term Corporate Bond ETF (Nasdaq:VCLT). The yields range from 2.3 to 4.8%, with VCLT boasting the highest yield. The expense ratio for all three ETFs is 0.15%. Based on performance in 2011, yield and expense ratio the best performing corporate bond ETF highlighted was VCLT. The Vanguard product is up 13% in 2011, and the yield is higher than LQD by 80 basis points. Past performance is not an indicator of future return, but with a higher yield and similar expense ratio, I would tend to lean towards VCLT if I were initiating a new position today.

The Bottom Line
Keep in mind that if the goal is to minimize volatility, and an above-average yield is not the main objective, the short-term maturity ETFs are the better choice. Consider CSJ or VCSH as investment options. (For more on choosing a bond for your portfolio, read Too Many Bonds To Choose From?)

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At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.

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