Market Overview

A Nifty Alternative Among Bond ETFs

A Nifty Alternative Among Bond ETFs

Interest rates are expected to continue rising in the United States with many market observers believing the Federal Reserve will follow up its March interest rate increase with one or two more rate hikes later this year. However, income investors are still looking for yield beyond U.S. government debt.

Plenty of fixed income exchange-traded funds can help investors with that objective, including the iShares U.S. Credit Bond ETF (NYSE: CRED). Often overlooked in the investment-grade corporate bond ETF conversation, CRED is neither young nor small. CRED turned 10 years old in January and has over $1.3 billion in assets under management.

Crooning Over CRED

CRED follows the Bloomberg Barclays U.S. Credit Bond Index, which is “composed of U.S. dollar-denominated, investment-grade corporate, sovereign, supranational, local authority and non-U.S. agency bonds,” according to iShares.

Although CRED is mostly a corporate bond ETF, it does hold some sovereign debt and supernational bonds. Investors should carefully consider how those type of bonds affect a fixed income portfolio.

“These bonds improve the portfolio's diversification, but tend to offer lower yields than their corporate counterparts with similar credit ratings and terms,” said Morningstar in a note out earlier this week. “The fund allocates roughly 15 percent of its capital to noncorporate securities, while most of its category peers do not invest in them at all. The remaining 85 percent of the portfolio is predominantly invested in A- and BBB rated bonds.”

To CRED's Credit: Holdings, Weighting

CRED holds over 3,200 bonds and has an effective duration of 6.9 years with a 30-day SEC yield of 3.11 percent. Approximately 77 percent of the ETF's holdings are rated A or BBB. Like many corporate bond ETFs, CRED is weighted market capitalization, another factor investors should consider.

“Market-cap weighting skews the portfolio toward the largest debt issuers, which may not offer the best potential returns,” said Morningstar. “In the intermediate investment-grade corporate fixed-income market, there have been record debt issuances by U.S. financial institutions in recent years. During 2016 alone, U.S. financial firms issued $299 billion of debt, pushing the sector's total outstanding debt to $1.6 trillion as of December 2016, according to Fitch. The issuances were largely driven by low rates and postcrisis regulatory changes.”

Over 19 percent of CRED's holdings are issued by banks while more than 13 percent are courtesy of consumer staples firms. Bonds issued by telecom and energy companies combine for over 15 percent of the ETF's roster.

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