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Investment markets have been bound by heightened uncertainty for the last several months. In an effort to manage risk in such an environment, many investors have sought to increase allocations to those areas of the market that they perceive to be relatively safe.

Included among these is the U.S. Investment Grade Corporate Bond market. After all, U.S. corporations are generally healthy with balance sheets flush with cash, so such allocations offer appeal not only for their implied relative stability but also for the attractive yields relative to U.S. Treasuries. And for those investors who are seeking to reduce their risk even further, they may seek to lower duration by allocating to the Short-Term U.S. Investment Grade Corporate Bond market. No worries right? Not so fast, as such exposures have the potential for unpleasant surprises and unusual risks.

A common way for investors to allocate to the Short-Term U.S. Investment Grade Corporate Bond market is the iShares Barclays 1-3 Year Credit Bond ETF (NYSEARCA:CSJ). For many investors, this seems like a natural fit at first glance, as it is the second largest credit bond ETF next to the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD). As a result, many believe it is nothing more than a broadly diversified Short-Term U.S. Investment Grade Corporate Bond offering, essentially a short duration alternative to the LQD. But when one looks under the hood, this is far from the case. Instead, a variety of unexpected risks quickly rise to the surface.

1. Heavy Financials

The CSJ gives investors a heavy dose of financials at over 30% of the entire allocation. And financials remain the sector at the core of the ongoing global crisis. Thus, investors are taking on a meaningful allocation to an area of the market that may be subject to heightened volatility, particularly if another financial contagion erupts.

2. Meaningful Exposures Outside Of U.S.

Roughly one quarter of the entire CSJ allocation is sourced from assets outside of the U.S. As a result, investors may find themselves with much greater global exposure than they might have anticipated with this allocation.

3. Direct Allocations To Global Regions Under Greatest Stress

What may be most surprising to investors is exactly where these global allocations reside. Roughly 25% of the entire CSJ product is allocated to sovereign, supranational and non-U.S. agency bonds. Some of these allocations include the following: European Investment Bank (6.13% of entire CSJ allocation), KfW Bankengruppe (5.08%) and Italy (0.50%) among others.

So while investors may perceive they may be better protected from downside shocks with an allocation to a Short-Term Credit product like CSJ, it is exposed to unexpected volatility in its own right. For example, during the depths of the financial crisis in late 2008, the CSJ dropped by -12% over a four-week period. The potential for sharp declines such as this over short-term periods may not be suitable for some safety seeking investors.

So what about Short-Term U.S. Investment Grade Corporate Bond alternatives?

The Vanguard Short-Term Corporate Bond ETF (NASDAQ:VCSH) provides a more traditional investment grade corporate bond allocation, but it also has its risks. It has an even bigger slug of financials than the CSJ at 44% of the entire product. And it also has direct exposure to Europe with a variety of bonds from some of the banks considered most at risk across the region.

The SPDR Barclays Capital Short Term Corporate Bond ETF (NYSEARCA:SCPB) has much the same story. It has a 42% allocation to financials that includes a number of European bank bonds.

So when seeking to manage risk in the current environment, beware of what might lurk under the surface of your investment allocations, as some offerings that might seem ultra safe may have meaningful direct exposures to the areas of the market that you may be specifically trying to avoid most.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Source: Short-Term Corporate Bond ETFs: Got Risk?