SPBO offers an attractive yield of 6% and a high-quality investment grade portfolio.The fund has declined significantly in 2022 and is still exhibiting weakness in 2023, but income investors should see this as a buying opportunity.Market fears, such as an economic recession, may negatively impact investment grade corporate bonds, but investors should take advantage of the opportunity to accumulate more shares.
Investment Thesis
SPDR Portfolio Corporate Bond ETF (NYSEARCA:SPBO) has a portfolio of investment grade corporate bonds in the United States. The fund has declined significantly in 2022 and is still exhibiting weakness in 2023. However, the fund is a good long-term holding as it currently offers an attractive yield of 6% and has a high-quality investment grade portfolio. Looking forward to the first half of 2024, an economic recession may trigger a market selloff, and investment grade bonds will likely be impacted negatively. However, income investors should treat this market fear as a good buying opportunity to accumulate more shares. We expect both capital appreciation and interest income over the long run.
Fund Analysis
SPBO is still in a slow decline in 2023
Let us first review the performance of SPBO in 2022 and 2023. In general, bond funds have not performed well last year. SPBO was not without exception. The fund has delivered a loss of nearly 20% in 2022. Even considering the interest income earned, the loss would still be 14.7%. The Federal Reserve's aggressive rate hike last year to combat persistently high inflation was the primary reason behind this decline. In the first half of 2023, SPBO performed much better but still in rangebound as the Federal Reserve slowed down its rate hike pace. However, the start of H2 2023 has not been promising as it appears that the Federal Reserve still has a long way to go to combat inflation and that it may take a while to reach the terminal rate. Therefore, as can be seen from the chart, SPBO has been in a decline mode in Q3 2023. Overall, the fund has delivered a total return of only 1.18% year-to-date thanks to its attractive 6%-yielding interest.
SPBO's portfolio of investment grade bonds is safe with low default rates
As can be seen from the table below, SPBO's portfolio consists of nearly 100% investment grade corporate bonds. These bonds have very low default rates and should be considered safe. In fact, the default rate for 3-year and 10-year investment grade corporate bonds are only 0.41% and 1.81% respectively. With a 6%-yielding interest income way higher than the default rates, we can safely ignore this default risk.
A negative spike will occur if the market is in a fear mode
Although SPBO's portfolio of funds is safe, the market may not perceive it this way, especially during troubling times. This is because the market still perceives corporate bonds as riskier assets than U.S. treasuries. In a market panic mode, (e.g., global pandemic, fear of a recession, or fear of a financial crisis), investment grade corporate bonds may experience sharp price decline. We have seen similar market selloffs in investment grade corporate bonds in past recessions. As the chart below shows, SPBO's fund price suffered a decline of nearly 20% during the outbreak of COVID-19 in 2020. Since SPBO's inception was in 2011, we do not have its historical chart during the Great Recession. However, other investment grade corporate bonds also exhibit similar negative spikes during the Great Recession. Therefore, we believe a negative spike of SPBO's fund price is not unlikely if recession fear mounts.
If the market's fear of a recession resulted in a significant decline in SPBO's fund price, we advise investors not to panic. As Warren Buffett usually says, “be fearful when others are greedy and be greedy only when others are fearful.” Therefore, investors should be greedy and make use of this opportunity to accumulate shares of SPBO as this opportunity usually do not last that long. SPBO's fund price will eventually return to its intrinsic value.
Investors need a long-term investment horizon to own this fund
Investors owning SPBO need to have a long-term investment horizon. Remember, SPBO does not own equities and that to expect short-term capital gain is unrealistic. However, we do expect some capital gains over the long run. As the Federal Reserve's rate hike comes into effect, inflation should eventually drop down to its 2% long-term target. Although the road may be bumpy, inflation should eventually cool down. As inflation continues to cool down, treasury yield will move lower, and this will result in higher bond prices. Therefore, SPBO's fund price will also benefit from higher bond prices. Investors owning SPBO should patiently wait for this to happen and earn a 6%-yielding interest income at the same time.
Investor Takeaway
For income investors wishing to own a quality portfolio of investment-grade corporate bonds, SPBO is a good choice. One should take advantage of its current attractive yield of 6% to accumulate. We also expect some capital gains along the way. Hence, this should be a good fund to own in the long run.
Additional Disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment