Depending on your stage of life or the asset allocation in your portfolio, bonds may be a solid choice to provide fixed-income stability and a hedge against more risky equity investments.
Within the category of corporate bonds, investment grade refers to the superior quality of a company's credit. To be considered an investment grade issue, the company must be rated at 'BBB' or higher by a credit rating agency such as Standard and Poor's or Moody's. Anything below this 'BBB' rating is considered non-investment grade. If the company or bond is rated 'BB' or lower it is known as junk grade, in which case the probability that the company will repay its issued debt is deemed to be speculative. Here, we look at investment grade ETFs.
- Well-diversified portfolios should have some allocation to corporate bonds.
- ETFs are a great way to get this kind of bond exposure in a diversified yet low-cost manner.
- Here, we look at just 3 of the many ETFs that contain investment-grade bonds.
Investing in Bond ETFs
Interest rates have been historically low for many years, making the gold standard, U.S. Treasuries, less attractive. That's where investment-grade corporate bonds come in. Corporate bonds offer significantly higher yields in many cases, without an equally significant bump in risk. Yes, corporations do go bankrupt on rare occasions, but investment-grade bonds focus on companies with excellent credit ratings and very low risk of default.
The problem is that picking institutional bonds is a skill best left to experts, and their fees can easily gobble up gains. Fortunately, there are a number of high-quality investment-grade corporate bond exchange-traded funds (ETFs) that are comparatively inexpensive and highly liquid. You also avoid the market-timing mistakes that so commonly befall amateur investors. Most investors should view bonds and bond ETFs as a strategic asset, a buy-and-hold investment that serves a specific purpose in their overall asset allocation.
Investors are subject to credit risks, such as default and downgrade risks, when investing in corporate bonds.
If you're looking for a few good corporate bond options to round out your portfolio, here are a few ETFs that rise above their peers. Funds were selected on the basis of a combination of assets under management (AUM) and overall performance. All data as of January 15, 2020.
1. iShares iBoxx $ Investment Grade Corporate Bond ETF
- Ticker: LQD
- Issuer: BlackRock
- Assets Under Management: $35.3 billion
- 2019 Performance: 17.37%
- Expense Ratio: 0.15%
This is the largest of the corporate bond ETFs and has returned 5.75% since its inception in 2002. The fund tracks the Markit iBoxx USD Liquid Investment Grade Index, investing roughly 90% of its assets into securities in the index, with the balance in cash funds. There are currently 1,971 holdings, heavily tilted toward the banking and consumer non-cyclical sectors. Top corporate bond issuers include Anheuser-Busch InBev SA/NV (BUD), GE Capital International Holdings Corporation, and Goldman Sachs Group (GS).
LQD's low expense ratio and solid performance figures make it an attractive choice. Trailing twelve-month, three-year, and five-year returns are 16.8%, 6.48%, and 4.62%, respectively.
2. Vanguard Short-Term Corporate Bond ETF
- Ticker: VCSH
- Issuer: Vanguard
- Assets Under Management: $25.9 billion
- 2019 Performance: 7.02%
- Expense Ratio: 0.05%
Short-term bonds generally mature within one to five years, and yields are lower than those of their longer-term cousins. This fund tracks the Barclays U.S. 1-5 Year Corporate Bond Index and invests about 80% of its assets into securities on the benchmark index. There are currently 2,198 holdings, almost entirely representing the financial and industrial sectors. There is a fairly even mix between bonds maturing in one to three years and those maturing in three to five years.
One of the advantages of short-term bonds is that they are less sensitive to rising interest rates—something to consider with the Federal Reserve on the move again. The fund's trailing twelve-month, three-year, and five-year returns are 6.90%, 3.36%, and 2.71%, respectively.
3. Vanguard Intermediate-Term Corporate Bond ETF
- Ticker: VCIT
- Issuer: Vanguard
- Assets Under Management: $26.3 billion
- 2019 Performance: 14.1%
- Expense Ratio: 0.05%
This fund uses an index-sampling strategy to match the performance of its benchmark index, the Barclays U.S. 5-10 Year Corporate Bond Index. There are presently 1,781 holdings in VCIT, the vast majority of which represent corporations rated either "A" or "Baa." Vanguard invests at least 80% of its assets in securities within the index.
Trailing twelve-month, three-year, and five-year annualized returns of 14.06%, 5.74%, and 4.42%, respectively, are robust given overall market conditions. Like other Vanguard funds, this one is quite inexpensive, charging just 5 basis points annually.