Bond ETF Idea: High Credit Quality Bonds

 

By Matt Tucker, CFA iSharesblog.com

First, the bad (and obvious) news: When it comes to investing, you can’t control returns. Now, the good news: You can manage the amount of risk in your portfolio, and managing risk is one way of influencing returns.

Take, for example, the investment grade corporate bond space, which consists of bonds rated AAA all the way down to BBB-. Until recently, most pooled investment vehicles such as ETFs and mutual funds offered investment grade access based on this typical definition. With last month’s launch of the iShares Aaa-A Rated Corporate Bond Fund (NYSE Arca: QLTA), investors now have a tool for targeting a specific amount of credit risk within their fixed income investments and, more specifically, can eliminate exposure to BBB-rated bonds.

Why would an investor want to slice and dice the corporate bond space using credit quality? I frequently speak with clients that have mandates that stipulate a minimum credit quality of A or higher for their bond portfolios. Just as many insurance companies and public unions have this requirement either by law or as a part of their investment policy statements, so do many individual investors feel generally uncomfortable with lower credit quality. For both groups, QLTA provides the ability to stay at the upper tier of the quality spectrum, while also offering diversified exposure across sectors and maturities.

Because of the reduced exposure to lower rated bonds, there is a tradeoff in yield vs. broader indices (see graph below). But the benefit of QLTA is that it allows investors to quantify what that tradeoff is worth.

 

 

 

 

 

 

 

 

 

 

 

 

 

We typically see clients using this in one of two ways.  First, as a complement to their broad corporate bond exposure (for example, the iShares iBoxx $ Investment Grade Corporate Bond Fund; NYSE Arca: LQD).  AAA to A bonds comprise about 71% of LQD, which means that 29% is BBB-rated bonds.  Adding an allocation to QLTA can tilt overall exposure toward the higher quality end of the spectrum.  And second, investors who are allocating their equity exposure to high quality companies can now take similar positioning in their fixed income portfolio.

About Matt Tucker, CFA

Matthew Tucker, CFA, Managing Director, is a member of the Product Strategy Team within BlackRock’s Fixed Income Portfolio Management Team. He leads the product strategy effort for exchange – traded funds, and leads the platform’s efforts in North and Latin America iShares. His team focuses on developing new fixed income iShares strategies, partnering with the iShares team on product delivery, and supporting iShares client sales.

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