The iShares Aaa-A Rated Corporate Bond ETF (NYSEARCA:QLTA) focuses on intermediate-term investment grade corporate bonds in the United States. The ETF tracks the Bloomberg Barclays U.S. Corporate Aaa–A Capped Index. QLTA has very low credit risk as all of the bonds in its portfolio are investment grade bonds. The fund has moderate interest rate risk due to the fact that its portfolio of bonds has an average duration to maturity year of 7.45 years. The ETF offers a 3%-yielding dividend. If you believe that a recession is coming, this may be an okay fund to own. However, if you believe a re-acceleration of the U.S. economy will happen in 2020, you may want to wait on the sidelines as its fund price may decline as the treasury yield rises in 2020.
Data by YCharts
When evaluating bonds, we typically look at three things. First, we look at whether the bond is safe or not (credit risk). Second, we look at how well these bonds are impacted by the interest rate (interest rate risk). Third, we look at whether this is the time to buy these bonds or not. So, we will go through this checklist one by one.
A portfolio of high-quality investment grade bonds
QLTA only holds investment grade corporate bonds (see chart below). This makes it a much better choice than other high-yield bond ETFs that hold non-investment grade bonds. In fact, investment grade bonds’ default rate is only about 0.10% per year (based on 32-year period measured). On the other hand, default rate for below-investment-grade bonds is forty times higher (about 4.22% per year). Not only does QLTA hold investment-grade bonds, it holds only A-rated investment grade bonds. Therefore, QLTA’s portfolio quality is higher than a regular investment-grade bonds that might include BBB rated investment grade bonds (the lowest rating investment grade bonds). This is because in an economic recession, many corporate bond issuers’ credit ratings may be downgraded. If a fund holds some BBB-rated investment grade bonds, it may be downgraded to non-investment grade bonds especially during an economic recession. Therefore, credit risk is very minimal for QLTA.
Source: iShares Website
Moderate interest rate risk
QLTA’s portfolio of bonds has an average effective maturity of 7.45 years. This is shorter than many long-term bond ETFs (10-20 years) but longer than short-term bond ETFs (less than 5 years). Its intermediate maturity term means that the fund’s performance is only moderately sensitive to the change of interest rates. As can be seen from the chart below, QLTA’s fund performance is still inversely correlated to the 10-year treasury rate.
Data by YCharts
Should we invest in QLTA now?
If you believe the U.S. economy is heading for a recession (and hence treasury rate will likely continue to drop lower), this may still be a good time to invest in this fund. However, we believe the U.S. economy is not heading for a recession, but only for a slowdown. In fact, we believe a re-acceleration of the economy may happen in 2020 with another rate cut by the Federal Reserve. This is because majority of the U.S. GDP is based on consumer spending rather than exports. At the moment, unemployment rate in the U.S. is still in a 50-year low. Therefore, the impact of global trade uncertainties on the U.S. is not material to U.S. consumer spending unless the tension escalates materially (e.g. tariffs going from 25% to 75%). We believe the Federal Reserve’s monetary policy of lowering its key interest rate in H2 2019 should help re-accelerate the U.S. economy. Once the U.S. economy re-accelerates, we believe the Federal Reserve may have to raise its key interest rate upward. Therefore, we may see higher treasury rates in H2 2020. As we know, QLTA’s fund price is moderately sensitive to the rising rate, its fund price will likely decline if the U.S. GDP growth re-accelerates. Therefore, this may not be the right time to invest in QLTA.
QLTA offers 3%-yielding dividend. This is still much higher than 10-year treasury bond that offers yield of about 1.8%. However, we think its fund price might decline in 2020 if the U.S. economy re-accelerates. Therefore, we think investors may want to wait on the sidelines.
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