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Long-term investment grade bonds refer to paper issued by large U.S. corporations with yields that are generally higher than U.S. government treasuries. As most of these bonds are AAA or AA rated, they represent a low risk – high return asset class which makes them particularly well suited for long term retirement investment options like IRA investments and 401K investments. Similarly, ETFs that invest in a wide portfolio of long-term corporate bonds or track a U.S. corporate bond index are called U.S. long-term investment grade bond ETFs.

Thanks to the near-zero interest rates in the U.S., most long-term corporate bond ETFs have a higher yield than government treasuries and municipal bonds. However, the current eurozone debt crisis which has been festering for the last two years has necessitated a flight to safety toward U.S. treasuries. This has led to a massive rally in government treasuries and municipal bonds and to significant under-performance by U.S. long term corporate bond ETFs. Having said that, we must realize that once Europe’s problems are resolved and global GDP growth picks up, U.S. long-term corporate bond ETFs will begin to significantly outperform other debt asset classes, assuming that inflation is still kept at bay.

Given below is a relative comparison of U.S. long-term corporate bonds vis-à-vis other debt instruments.

Fixed Income Assets Trend

11/17/2011

Description

Symbol

1 Week

4 Weeks

13 Weeks

26 Weeks

52 Weeks

Trend Score

20+ Year Treasury

TLT

2.59%

4.66%

9.07%

27.6%

29.45%

14.68%

10-20Year Treasury

TLH

1.2%

3.01%

3.52%

16.26%

17.15%

8.23%

Inflation Protected

TIP

-0.84%

1.93%

1.12%

8.5%

11.68%

4.48%

Intermediate Treasury

IEF

0.6%

2.05%

1.4%

11.28%

11.2%

5.3%

National Muni

MUB

-0.12%

0.4%

0.82%

4.42%

8.73%

2.85%

Long Term Credit

LQD

-1.38%

-0.2%

-0.31%

3.08%

6.66%

1.57%

US Total Bond

BND

0.02%

0.78%

0.47%

4.61%

6.19%

2.41%

MBS Bond

MBB

0.07%

0.54%

-0.35%

2.72%

4.43%

1.48%

Emerging Mkt Bonds

PCY

-1.16%

1.41%

-0.18%

3.31%

4.36%

1.55%

For more on the performance of various asset classes, see here.

As we can see, government treasuries and municipal bonds have significantly outperformed U.S. long term corporate bond ETFs. However, this trend can reverse abruptly if major problems like the eurozone debt crisis are resolved satisfactorily.

Let us now take a closer look at the most prominent and liquid U.S. long term corporate bond ETFs that are traded currently.

U.S. Long Term Investment Grade Bonds

11/18/2011

Description

Symbol

1 Yr

3 Yr

5 Yr

Avg. Volume(K)

1 Yr Sharpe

Vanguard Long-Term Corp Bond I

VCLT

15.72%

NA

NA

46

212.61%

SPDR Barclays Capital Long Corp

LWC

14.8%

NA

NA

23

165.53%

iShares iBoxx $ Invest Grade Corp

LQD

6.84%

12.96%

6.06%

1,614

136.65%

For more on various ETFs linked to different asset classes, see here.

When we analyze the data given above, it becomes obvious that LQD is the most liquid (1,614K daily average volume) and the oldest (more than five years old) ETF in the above given table. However, VCLT has the highest short term return (15.72%) and the best one year Sharpe ratio (212.61%). Keeping these numbers in mind, let us examine VCLT’s core holdings and portfolio credit quality.

Bond Ratings (%)

Sector

VCLT

Category Avg

US GOVERNMENT

N/A

N/A

AAA

3.57

N/A

AA

10.78

N/A

A

44.83

N/A

BBB

40.82

N/A

BB

0.00

N/A

B

0.00

N/A

BELOW B

0.00

N/A

OTHER

0.00

N/A

Top 10 Holdings (9.49% of Total Assets)

Company

Symbol

% Assets

CMT Market Liquidity Rate

N/A

1.58

General Elec Cap Corp Mtn Be 6.75%

N/A

1.22

At&T 8%

N/A

1.14

Pfizer 7.2%

N/A

0.93

Wal Mart Stores 6.5%

N/A

0.90

Comcast Corp New 6.95%

N/A

0.79

At&T 6.8%

N/A

0.76

Goldman Sachs Grp 6.75%

N/A

0.75

Deutsche Telekom Intl Fin B V 8.75%

N/A

0.73

Shell Intl Fin Bv 6.375%

N/A

0.69

VCLT’s core holdings consist of bonds issued by top U.S. corporations like GE (GE), AT&T (T), Pfizer (PFE), Wal-Mart (WMT), Goldman Sachs (GS), etc.. Similarly 59.2% of VCLT’s bond investments are rated A and higher and the balance 40.82% is made up of BBB rated paper. This makes VCLT’s portfolio safe with little or no chance of default. However, any further deterioration in the U.S. economy, for example a double dip recession, can lead to some serious price volatility, especially in the bonds issued by financial companies like Goldman Sachs and others.

In addition, long term bonds are also subject to interest rate risk. When inflation is rising, investors will demand higher yields and thus driving down these bonds' prices.

The takeaway is that asset allocation to U.S. long term corporate bond ETFs like VCLT gives the average investor/money manager a low risk way to hedge his/her bond portfolio without compromising on returns in the long term.

Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Source: U.S. Long-Term Investment Grade Bond ETFs: High Yields With Stability