At the height of the extended bull market, risky less-than-investment-grade bonds were in vogue with their attractive yields, particularly in a rising rate environment, but BBB bonds that are on the cusp of high yield status could be facing a liquidity crisis, according to a recent CNBC report.
As the volatility seen has been racking the stock markets as of late, it has also affected the bond markets, particularly liquidity - the ability purchase and sell an asset within a reasonable amount of time. BBB bond markets are especially susceptible because institutional investors, who carry war chests full of capital that aid in liquidity, aren't able to invest in these bonds if they become high yield or "junk" issues.
BBB bonds comprise almost 50% of the $5.8 trillion investment-grade bond market and a lack of liquidity could leave BBB bond investors holding the debt as it toes the line between investment grade and junk bond status - the worry, of course, being that it may eventually fall into the category of the latter.
"There's a lot of worry about the BBB-rated world," said Jason Shoup, head of global credit strategy at institutional asset manager Legal & General Investment Management America. "It's not an issue today, but in a recession, it's possible that between $500 billion and $1 trillion in BBB-rated bonds could slide into the high-yield market."
In order to avoid a possible liquidity crisis, investors can opt for more liquid exchange-traded funds that allocate capital into investment-grade debt issues.
1. iShares 1-3 Year Credit Bond ETF (CSJ) (NASDAQ:IGSB)
CSJ tracks the investment results of the Bloomberg Barclays U.S. 1-3 Year Credit Bond Index where 90 percent of its assets will be allocated towards a mix of investment-grade corporate debt and sovereign, supranational, local authority, and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to three years - this shorter duration is beneficial during recessionary environments.
2. Deutsche X-trackers Investment Grade Bond Interest Rate Hedged ETF (NYSE:IGIH)
IGIH seeks investment results that track the performance of the Solactive Investment Grade Bond - Interest Rate Hedged Index where a portion IGIH's total assets will reside in long positions in U.S. dollar-denominated investment-grade corporate bonds. As in the case of IGHG, this strategy effectively eliminates exposure to riskier bonds with fund allocations in investment-grade issues.
3. ProShares Investment Grade-Interest Rate Hedged ETF (NYSE:IGHG)
IGHG tracks the performance of the Citi Corporate Investment Grade (Treasury Rate-Hedged) Index with long positions in investment grade corporate bonds issued by both U.S. and foreign domiciled companies. This is particularly important during market downturns when the propensity for a company to default on its debt is higher. As such, IGHG focuses on investment-grade issues to reduce credit risk.