Fed rate hikes have made some corporate bonds very attractive. How to profit from it
As stocks fall and interest rates rise, investors are more excited about corporate bonds than they have been in a generation. A side effect of the Fed’s tightening policy is that interest rates have risen everywhere, including in the corporate bond market. But as the pros point out, investors need to be cautious and consider things like credit risk and interest rate sensitivity as a recession could loom. Because of this, bond investors are being steered towards shorter-duration bonds, in the 2-year sector and below, which have the highest yields in years but have less risk than longer-dated bonds. They also prefer higher-quality, low-quality, high-yield or junk bonds. “If you look at investment-grade yields of around 5.4%, that’s a level of yield that investors haven’t seen since 2009, and that was obviously a very different spread environment than what we’re doing now,” Jonathan said Duensing, head of US Fixed Income at Amundi Asset Management. Bond prices fall when yields rise, so investors who buy now could see their bonds fall in price if interest rates continue to rise. But Duensing said the high yields are now acting as a cushion for investors in shorter-dated bonds. “The yields are high. If you’re talking about a two to three year investment horizon, the vast majority of these investment grade securities actually mature,” he said. “If you invest in something with a 5% yield and a 2-year maturity, you can get that 5% yield. There will be some volatility, but the point is that the yield can protect you from some short-term volatility.” Stick to quality Investors can make their own bond purchases of individual corporate bonds in increments of $1,000, but strategists warn that it’s best to stick with the highest quality bonds at this uncertain time, when a recession could set in. “What’s going on at the short end of the yield curve undoubtedly has good value, and I think it will be a good investment,” said Gilbert Garcia, managing partner at Garcia Hamilton Associates. “Any widening in corporate spreads will likely be offset by falling Treasury yields, but I’d stick with the quality names.” Garcia said he likes names like IBM and Apple.According to Tradeweb, the 2-year IBM bond yielded 4.71%.It was rated A- by Standard and Poor’s and A3 by Moody’s rtet. Apple’s 2-year bond, rated Aaa by Moody’s and AA+ by S&P, returned 4.29%, according to Tradeweb. Garcia said he avoids finance. “Finance itself, banks and brokers are expanding. Corporate bond spreads are likely to widen, but when you’re that tight, breaking even gives you plenty of room to go before you lose money,” Garcia said. Garcia said he also likes Aflac, Walt Disney, Deere and Caterpillar. According to Tradeweb, a 5-year Aflac returned 4.88%, while a Deere 2-year returned 4.42% and a Caterpillar 2-year returned 4.46%. Anthony Watson, founder of Thrive Retirement Specialists, said he advises clients at his Dearborn, Michigan firm to consider corporate bonds as one of nine asset classes. “We believe it makes sense to own this asset class. We have chosen to access corporate bonds through a highly diversified, low-cost index fund and one reason is that there are more difficulties with corporate bonds than with government bonds,” he said. Government bonds are affected by maturity, while corporate bonds have credit risk and could be affected by a credit rating downgrade, for example.Playing FundsOne fund that tracks short-term corporate bonds is the SPSB, SPDR Portfolio Short Term Corporate Bond ETF.Other short-term funds have seen declines, but they have seen the decline in the S&P 500 in outperformed by more than 19% this year.The SPSB ETF, which tracks the Bloomberg 1-3 year corporate bond index, is down 5.4% year-to-date.The short-term funds also have the popular iShares iBoxx $ Investment Grade Corporate Bond ETF LQD outperformed, which holds bonds with longer maturities and this year bi has lost 22.3%. According to BlackRock, the weighted average maturity is 13.22 years. There’s also the Vanguard Short-Term Corporate Bond ETF VCSH, which tracks a corporate bond index that’s down 8.5% this year. The iShares 1-5 year Investment Grade Corporate Bond ETF IGSB is also roughly on par. It tracks the ICE BofA 1-5 Year US Corporate Index. There’s the PIMCO Enhanced Short-Maturity Active ETF MINT, discounted 2.5% for the year. About half of the ETF is investment-grade bonds. It also holds securitized assets and other short-dated instruments. Watson said he prefers a multi-holding ETF approach because credit risk could be an issue. He said the Fed’s dovish stance made the market concerned that the central bank will push the economy into recession. “Now that means investors need to be rewarded more for taking that credit risk. If we go into a recession, some companies will struggle,” he said. He added that interest rate action has changed perceptions of bond investing, which has been poorly performing for years. “I think there are opportunities in the space for a while. You have two different things going on. They have an economy that’s not doing well, that’s slowing down and maybe headed for a recession,” he said. “It will depend heavily on the Fed’s interest rate outlook.”