TLT iShares 20 plus Year Treasury Bond

Thanks to rock-bottom interest rate of government backed bonds which offer safe haven opportunities, the U.S. corporate bond market has been on a rocky path as these normally yield higher than their Fed cousins. Also, a slow-but-steady U.S. market recovery and strengthening of corporate America have helped the related high yield bond market to climb.

As per Wall Street Journal, “purchasers of corporate debt are demanding the smallest interest-rate premium to comparable government bonds since 2007”. In general, a company needs to exhibit a steady earnings trend to be able to issue debt securities to the public at a favorable coupon rate (read: Time to Buy This Corporate Bond ETF?).

When a company’s credit quality apparently improves, it becomes easier for it to issue increased amounts of debt at low rates. This is why default risk remains low if investors put their money into investment-grade bonds of some well-established companies.

Let’s come to the interest rate risk. While the bond market saw a turbulent 2013 thanks to the initiation of taper talk and the resultant rise in long-term interest rates, volatility in rates have largely bottomed out this year. In 2014, rates have not been rising as expected previously. The Fed has also pared down its prior hints of short-term rate hike (possibly next year) thus underpinning the low chances of interest rate rises this year.

Even if long-term rates rise, inflation adjusted real rates should not prevail at sky-high levels over the long term. Notably, as the U.S. economy shifts to top gear, inflation will also see an uptick. Investors should note that, the Fed’s decision on further taper in 2014 will depend on whether inflation and employment perk up at a desired pace.

This means that a gradual interest rate rise in a modestly inflationary environment may not prove all that bad for the long-term bond ETFs (read: Comprehensive Guide to U.S. Junk Bond ETF Investing).

Thus, with each and every condition being fulfilled for high-quality corporate bond markets, a look at the top ranked ETF in the Corporate Bond space would be the best way to capture the uptrend and cater to investors seeking higher yields without too much extra risk:

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box or asset class (Read: Zacks ETF Rank Guide). Our proprietary methodology also takes into account the risk preferences of investors. ETFs are ranked on a scale of 1 (Strong Buy) to 5 (Strong Sell) while they also receive one of three risk ratings, namely Low, Medium or High.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of the five ranks within each risk bucket. Thus, the Zacks ETF Rank reflects the expected return of an ETF relative to other products with a similar level of risk.

For investors seeking to apply this methodology to their portfolio in the corporate bond space, we have taken a closer look at the top ranked LWC. This ETF has a Zacks ETF Rank of 2 or ‘Buy’ rating with a high risk outlook (see the full list of top ranked ETFs) and is detailed below:

SPDR Barclays Long Corp Term Bond ETF (LWC)

This fund looks to track the Barclays Capital Long U.S. Corporate Index. This Index intends to measure mainly the performance of U.S. corporate bonds that have a maturity of greater than or equal to 10 years. The corporate bonds have high investment grade rating as well.

The ETF targets the longer end on the yield curve with a weighted average maturity of 24.08 years. It is subject to high levels of interest rate risk primarily due to its long-term focus as indicated by a weighted average duration of 13.72 years. Also, in terms of credit risk, the ETF seems decently placed with investment grade bonds occupying 80% of the portfolio.

However, the ETF is an appropriate choice for investors seeking high yield. The ETF’s yield-to-maturity hovers around 4.58% (as of April 15, 2014) which is higher than the 3.46% yield offered on 30-year treasury bonds.
Year-to-date, LWC has returned investors 8.64%. We currently give LWC a Zacks ETF Rank of 2 or ‘Buy’ rating along with a high risk outlook.

Bottom Line

In short, with corporate America definitely on a roll, 2014 should be the year for corporate bonds, definitely the ones with investment grade ratings. We at Zacks have plenty of buy-rated corporate bonds while no government bonds are presently top rated (read: Zacks Top Ranked Corporate Bond ETF: LQD).

High quality corporate debt should outperform U.S. government bonds this year thanks to their higher-yield nature even if interest rates rise. This high yield nature of the corporate bonds will likely make up for the erosion in capital appreciation in a rising rate scenario, and especially if rates slowly move higher over the course of the next few years.

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SPDR-BC LT CR B (LWC): ETF Research Reports
 
ISHARS-20+YTB (TLT): ETF Research Reports
 
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