Fixed income (bonds) is one of the most important assets for a portfolio: it provides regular income with stable prices. During market stress, it is an anchor to stabilize a portfolio while providing opportunites to re-balance (buy low) at market bottoms.
Recent market volatility has increased demand for safer bonds. In corporate bonds, debts with highest ratings (between AAA to BBB) are considered to be investment grade, compared with those rated lower (called high yield or junk bonds). Intermediate investment grade bonds have an average maturity of 5 to 7 years.
U.S. Intermediate Term Investment Grade Bonds 05/27/2011
1 Yr Sharpe
|Vanguard Interm-Tm Corp Bd Idx ||VCIT ||11.02% ||NA ||NA ||65 ||234.95% |
|iShares Barclays Intermediate ||CIU ||7.13% ||6.23% ||NA ||201 ||210.77% |
|iShares Barclays Credit Bond ||CFT ||8.01% ||6.48% ||NA ||54 ||203.42% |
|SPDR Barclays Cap Interm Term ||ITR ||7.16% ||NA ||NA ||37 ||198.16% |
|PIMCO Investment Grade Corp Bd ||CORP ||NA ||NA ||NA ||2 ||NA |
Based on the above table, VCIT is the best performer in its category but in terms of volume we would prefer CIU.
Reviewing these ETFs a little more closely:
: The fund employs a “passive management”—or indexing—investment approach designed to track the performance of the Barclays Capital U.S. 1–5 Year Corporate Index. This index includes U.S. dollar-denominated, investment-grade, fixed-rate, taxable securities issued by industrial, utility, and financial companies, with maturities between 1 and 5 years.
all follow the same Barclays index. Apparently, Vanguard has done better job in terms of managing its index tracking.
PIMCOs Investment Grade Bond (CORP
), on the other hand, follows the BofA Merril Lynch US Corporate Index. It has less than 1 year of historical returns. The following chart shows the comparison between VCIT and CORP. They are closely matched.
Vanguard's VCIT and SPDR's ITR both have lowest expense ratio at 0.15% while the other three all charge 0.20% annually.
What is the future outlook for intermediate term bonds? Many analysts believe we are in a bond bubble. As interest rates are near zero, there is no way that the rate could go any lower from here. Eventually there will have to be a rise in yields. This is somewhat true with the 3-month treasury bill rates. Thirty-year treasuries currently stand at approximately 4.5%. This is already a 100 basis point rise from August’s low in rates of 3.5%. However, over the past ten years, 30-year treasury bonds have mostly been in the 3.75% to 5.25% range, with the average about right where they are today – 4.5%. Typically, long treasury yields approximate inflation plus about 2.1% real return. At today’s rates this implies inflation of about 2.4%, versus actual inflation of less than 1%. We think there is room for long treasury bonds to increase in price from these levels. This means intermediate-term bonds are in a sweet spot.
Compared with high yield bonds, investment grade bonds provide a safer alternative that allows investors to capitalize on the strong balance sheets enjoyed by U.S. companies at the moment.
Ultimately investing in bonds protects investors from the volatility of the market. Both Vanguard and PIMCO provide the best choices here if investors decide to have exposure to intermediate term investment grade bonds.
Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.
Disclosure: Author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.