iShares iBoxx $ Investment Grade Corporate Bond ETF has declined over 28% since late 2021, offering an attractive yield near 6%.LQD has a portfolio of investment grade corporate bonds with low default risk and has outperformed U.S. treasuries in terms of long-term returns.While LQD may experience temporary declines in an economic recession, investors should consider owning the fund for potential capital appreciation and interest income.
ETF Overview
iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD) owns a portfolio of investment grade corporate bonds in the United States. This fund has an expense ratio of about 0.14%, not the lowest, but also not expensive. The fund has declined more than 28% since reaching the peak in late 2021. Thanks to the decline in its fund price, it currently offers an attractive yield near 6%. The fund has a portfolio of investment grade corporate bonds with low default risk. It also offers better long-term returns than the U.S. treasury. While LQD may sharply decline in an economic recession, this decline is typically temporary. Therefore, investors should be owning this fund right now and be prepared to add more shares if its price falls further due to a market selloff. We expect both capital appreciation and decent interest income over the long term.
Fund Analysis
LQD has declined significantly since the peak reached in late 2020
Let us take a closer look at how LQD performed in the past 3 years. In general, bond funds have not performed well. LQD is not without exception. As can be seen from the chart below, LQD has reached its peak in late 2020, and it has been in a slow decline in much of 2021. As inflationary pressure built up throughout 2021, the Federal Reserve was forced to aggressively hike the rate in 2022. As a result, LQD’s fund price started to decline sharply in the same year and reached a trough in October 2022. In total, the fund has declined from the peak to the trough by over 28%. Although LQD has rebounded towards the end of 2022, it continued to trend down in 2023. Its current price of $100.68 per unit is now closer to the trough reached in October 2022. Thanks to the significant decline, the fund’s 30-day SEC yield of 5.97% is now quite attractive.
LQD has low long-term default rates
Let us now examine some important characteristics of this fund. We will first take a look at its credit risk. As can be seen from the table below, LQD’s portfolio consists of nearly 100% investment grade corporate bonds. Nearly 54% of its bonds belong to A rated or higher credit ratings. BBB rated bonds represent about 45.7% of LQD's portfolio.
Below is a table that shows the top 10 holdings of LQD. As can be seen from the table below, the top 6 holdings belong to the financial sector. These issuers are well-known financial institutions with solid credit ratings. For example, JP Morgan Chase and Bank of America both have credit ratings of A+. Its 10th holding, Apple, has a credit rating of AA+.
These investment grade bonds have low default rates. In fact, default rate for 3-year and 15-year investment grade corporate bonds are only 0.41% and 2.66% respectively.
LQD has outperformed other treasury funds
Investment grade corporate bonds usually have higher interest yield than treasuries as it is backed by the full faith and credit of the U.S. government. In fact, the U.S. government has never defaulted in the past. Therefore, the U.S. treasury is often perceived as a risk-free asset. Therefore, it has a lower interest yield than corporate bonds. Over the long run, LQD’s total return has exceeded that of U.S. treasuries. Let us compare LQD with Vanguard Intermediate-Term Treasury Index Fund ETF Shares (VGIT). As can be seen from the chart below, VGIT’s total return since 2010 was only 25.66%. On the other hand, LQD’s total return was nearly 56%, more than double the return of VGIT.
Be prepared for a negative spike in market selloffs
While LQD’s portfolio of bonds is generally safe, in a market selloff, investment grade corporate bonds may experience a sharp price decline. As we explained earlier, investment grade corporate bonds are still perceived as riskier assets than U.S. treasuries. Therefore, it tends to decline sharply when the market is in panic mode. In fact, LQD has declined sharply in the past two recessions. As can be seen from the chart below, LQD’s fund price dropped significantly in the Great Recession in 2008/2009, and during the initial outbreak of COVID-19 in 2020.
In contrast, treasury funds such as VGIT did not exhibit this negative spike at all. As can be seen from the chart below, VGIT’s fund price was firm even during the initial outbreak of COVID-19.
Should investors be owning this fund?
We believe now is a good time to own LQD as it offers an attractive interest yield right now. In addition, there is also potential for long-term capital appreciation due to easing inflation. While combating persistent inflation may be a lengthy battle, we are seeing signs that inflation is gradually cooling down. Whether this will cause a hard-landing or a soft-landing of the economy is still uncertain. However, in either case, investors of LQD should benefit. If the economy heads for a soft landing and that inflation is gradually under control, the Federal Reserve should have room to ease its monetary policy. This should result in a decline in bond yield and higher bond prices. Even if the economy heads for a recession, we do not think investors need to panic. As we have discussed earlier, we have seen a negative spike in LQD’s fund price in the past two recessions. However, these negative spikes were temporary. We believe investors should not be hesitant and should be buyers of LQD in such a scenario. Eventually, LQD’s fund price will return to normal. Therefore, we believe investors may want to start accumulating LQD now and average down on any sharp declines.
Investor Takeaway
For long-term income investors wishing to earn attractive interest income, LQD is an excellent choice. Not only because it has a quality portfolio with low credit risk, but investors should also be able to see capital appreciation along the way. Hence, LQD should be a good ETF to own right now.
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.