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LQD: Outperforming So Far In 2020, Lowering Outlook From Here

Summary

  • LQD has been a terrific equity hedge so far in 2020, and it has beaten the broader bond and equity markets since my buy recommendation.
  • Despite bullish momentum, the Fed's decision to lower rates may leave fewer potential tailwinds going forward.
  • LQD has quite a high duration, and investors have been shedding longer-term bond exposure in recent weeks.

Main Thesis

The purpose of this article is to evaluate the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD) as an investment option at its current market price. Earlier this year, I noted how I found LQD's outlook attractive, and recommended investors obtain some exposure for a few reasons. One, I saw a macro environment favoring quality bond assets and two, I believed equity markets were a bit too frothy.

In hindsight, this thesis has proven correct, as LQD has had a terrific start to 2020 and equity markets have indeed come under pressure. Looking ahead, I see a challenging market for equities, and continue to believe investors should focus on fixed-income sectors for diversification. However, given LQD's move higher in the short-term, I am advocating a more cautious stance. Specifically, I believe the recent Fed action has now removed an important catalyst for bond funds as it is now priced in. This could limit upside potential from here. Additionally, investors are limiting their duration risk right now, which is especially important if the Fed does not plan to lower rates further. With investors beginning to rotate out of longer term bonds, this could eventually trickle down to LQD, which has an effective duration above nine years.

Background

First, a little about LQD. The fund's stated objective is "to track the investment results of an index composed of U.S. dollar-denominated, investment grade corporate bonds". LQD is currently trading at $133.27/share and yields 3.06% annually. When I covered LQD in January, I had a bullish outlook on the fund. While I did like the fund, much of this was also driven because I felt equity prices were ripe for a correction, and I had been advocating fixed-income products as a hedge. In hindsight, this was a good call, as LQD has seen a nice return since then, while the broader market has come under quite

This article was written by

Dividend Seeker profile picture
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I began my career in financial services in 2008, at the height of the market crash. This experience has shaped my investment strategy - which is focused on diversification, dividends, and growth opportunities. I am a competitive tennis player, and I competed at the Division I level in undergrad. I have a Bachelors and MBA in Finance.

(He is a contributing author for the investing group CEF/ETF Income Laboratory where he specializes in macro analysis. Features of CEF/ETF Income Laboratory include: managed income portfolios (targeting safe and reliable ~8% yields) making use of high-yield opportunities in the CEF and ETF fund space. These are geared toward both active and passive investors of all experience levels. The vast majority of holdings are also monthly-payers, for faster compounding and steady income streams. Other features include 24/7 chat, and trade alerts. Learn more.)

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (11)

t
I see the high yield bond market in tremendous turmoil in the coming months with an unprecedented number of defaults. Equity markets in turmoil!! Where should one interest? Investment grade corporate bonds at a nearly 4% return. I see the recent drop in LQD as a result of investors liquidity and a need for cash. My conviction is high that LQD has a tremendous up side in the coming months.
Your opinion would be greatly appreciated
Thanks
Dividend Seeker profile picture
While I thought LQD was going to see some short-term pressure, I will be honest in saying I in no way predicted a 20% drop since publication! I absolutely continue to have faith in top graded US corporates, and I would look to enter funds like this in the week ahead. I already increased my exposure to investment grade munis, corporates are likely next. That said, all investors should prepare for more downside potential from here. Markets look set to be volatile for weeks to come.
Erich Reimer profile picture
LQD at historic lows since the depths of the 2008 financial crisis just looks too attractive to me to not have some kind of buy-in. There are serious, unprecedented risks in terms of defaults and corporations issuing tons of new debt, and risks in the inherent structural illiquidity of many corporate bonds that is being stressed from the fund outflows, but as a buying-in point this still can look potentially intriguing I think from many angles.
Dividend Seeker profile picture
I agree with you, as long as you don't need the cash, why not try?
Dividend Seeker profile picture
Switching to a less bullish rating was quite timely
Elusive Value profile picture
@Dividend Seeker , thanks for the write-up. Have your thoughts changed on BBB-rated bonds following today's oil-driven market drop? Interestingly, iShares also has an ETP (ticker FALN) that aims to buy bonds that lose their BBB rating, but it seems even if there was some sort of mechanism between LQD and FALN, LQD would still stand to lose NAV if a wave of downgrades were to occur.
Dividend Seeker profile picture
I continue to see that amount of BBB rated bonds as a percentage of total investment grade corporate debt as a risk to the sector. That said, I do not foresee large scale downgrades or defaults yet...but if the selloff continues that becomes a much larger probability
cherryneverland profile picture
LQD, TLT & GLD are the best recession-proof investments in turbulent times
Dividend Seeker profile picture
Sounds like a good lineup!
Cuip99 profile picture
I have owned LQD for quite a while. I am very happy with it. I shall not add to it nor shall I sell it.
Dividend Seeker profile picture
I think that is the right move here
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