ETF investors have been wholeheartedly embracing this year’s surge in interest rates, as they have plowed billions of dollars into everything from ultra-short-term bond ETFs to zero-coupon long-bond ETFs and everything in between.
Year-to-date inflows for fixed-income ETFs total $142 billion, or 41% of the total inflows for U.S.-listed ETFs this year.
Some bond ETFs, like the iShares 20+ Year Treasury Bond ETF (TLT) and iShares 0-3 Month Treasury Bond ETF (SGOV), have been massive winners, with inflows of $18.4 billion and $9.5 billion, respectively.
But the love for bond ETFs hasn’t extended to all corners of the exchange-traded-fund universe. Corporate bond ETFs have netted outflows of $9.2 billion this year as some of the biggest corporate bond funds see substantial outflows.
The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), for instance, has had outflows of $6 billion so far in 2023.
Corporate Bonds vs Treasuries
The stark contrast between the outflows for corporate bonds and the inflows for bond ETFs more broadly may come down to perceptions about risk.
Most of the inflows for bond ETFs this year have gone into Treasury ETFs. Those ETFs have gathered a collective $95 billion of new money.
With rates on Treasuries across the yield curve now above 5%, investors are getting significant income without taking on much, if any, risk.
For investors who want no credit risk and minimal duration risk, ETFs like SGOV are available. For investors who want no credit risk and the potential returns that come from a drop in interest rates, a whole spectrum of short-to-long term Treasury bond ETFs are available.
Corporate bonds offer little benefit to the investors seeking to profit from an interest rate decline, many of whom have crowded into TLT.
And even for the investors seeking income, they’re not offering a whole lot more than is available with Treasuries. The extra return that investors get in junk bonds versus Treasuries is around 4.7%, only about 40 basis points more than the five-year average; while they get 155 basis points more in investment grade corporate bonds, or 10 basis points less than the five-year average.
In an environment of ultra-low interest rates, those types of credit spreads might have made sense to ETF investors. But with the 10-year Treasury yield at 16-year highs, they don’t have quite the same appeal.
That’s especially the case when you consider that many investors are betting on an economic slowdown that might cause corporate defaults to tick up and yield spreads to widen. After all, it’s the reason why so many investors have piled into TLT.
Of course, ETF investors could be wrong. Their bets on a long bond rally and a weakening economy have been far off the mark so far. And if the economy keeps humming, corporate bonds may yet prove to be a good investment.