It is the best of times for corporate bond issuers. It's a pretty good time for corporate bond ETF investors too. But investors should avoid the temptation to buy investment grade corporate bonds and corporate bond ETFs now. The yields are too low and the risks are too high.
Investment grade corporate bond ETFs, like the bonds they hold, are currently trading on interest rates. Interest rates are low and the expectation is that they will stay low.
Corporations are taking the situation as an opportunity to issue a lot of debt. Companies like Microsoft that have traditionally eschewed debt are getting in on the act. The yields on this new debt are very low. The most recent is Wal-Mart's three-year and five-year debt offering at rates of 0.75% and 1.5% respectively. Less worthy companies like Pepsico and even eBay are forced to pay more. But not much more. Ebay is offering just 0.875 percent on its 3-year notes. This is better than the plain vanilla money market account and U.S. treasury bonds, but not by much.
At these levels, corporate bonds are pricing in very little risk from all this new supply. They are pricing in little default risk, little liquidity risk, and in fact very little interest rate risk.
Since the Fall of 2009, investors have pushed aside default risk and liquidity risk. The focus is mainly on interest rates. Lower interest rates helps both LQD and IEF. The two have resumed similar paths.
Investment grade bond ETFs have only small positions in the lowest yielding bonds, like Microsoft and Walmart. They mostly have longer average maturities and therefore higher yields than the short term corporates. LQD currently yields about 5%. It has an average maturity of 12 years. iShares Barclay's Credit Bond fund (NYSEArca:CFT) yields about 4.5%, average maturity of 10 years. iShares Lehman 1-3 Year Credit Bond(PCX:CSJ), the safest of the three, pays just 3% and has an average maturity of about 2 years.
The main risk to ownership of investment grade corporate bond ETFs is the direction of interest rates. The Federal Reserve is easing. Inflation may be the result. If higher rates follow inflation then corporate bond yields will rise and bond prices will fall. If the Fed allows inflation without raising interest rates, the meager returns of bond ETFs will just be eaten away.
Following are U.S. Investment Grade Corporate and Aggregate Bond ETFs:
Investment Grade Bond ETFs:
iShares iBoxx Investment Grade Corporate Bond (NYSEArca:LQD)
iShares Credit Bond (NYSEArca:CFT)
iShares Barclays 1-3 Year Credit Bond (NYSEArca:CSJ)
iShares Barclays Intermediate Credit Bond (NYSEArca:CIU)
Aggregate Bond (corporate, agency, MBS, treasury) ETFs:
iShares Barclay Aggregate Bond (NYSEArca:AGG)
Vanguard Total Bond Market (NYSEArca:BND)
SPDR Lehman Aggregate Bond (NYSEArca:LAG)
iShares Barclays Interm Government/Credit Bond (NYSEArca:GVI)
iShares Barclays Government/Credit Bond (NYSEArca:GBF)