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Another ETF Idea For Trump Tax Reform

October 24, 2017 8:26 am
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Another ETF Idea For Trump Tax Reform

The Trump administration is pushing a massive tax reform package, which, after several legislative failings, has become the centerpiece of the president's agenda. Equity investors believe tax reform, if successful, will benefit an array of sectors, but stocks are not the only asset class poised to get a boost if the tax code is overhauled.

A deeper look into the possibility of tax reform reveals some fixed income assets, including corporate credit, could benefit from the White House's tax efforts. Should President Donald Trump's tax reform efforts come to life, corporate bond exchange-traded funds, including the WisdomTree Fundamental U.S. Corporate Bond Fund (BATS: WFIG), could benefit over the long term from declining issuance and improving credit quality.

WFIG can be a complement or alternative to traditional investment-grade corporate bond exposure because its underlying index, the WisdomTree Fundamental Corporate Bond Index, selects bonds “that are deemed to have attractive fundamental and income characteristics,” according to WisdomTree.

Talking Taxes

WFIG, which has a 30-day SEC yield of nearly 3 percent, holds 80 corporate bonds. Nearly 91 percent of the ETF's holdings are rated A or BBB.

“In the short run, tax cuts could  increase earnings, increase free cash flow and stabilize P/E multiples,” said WisdomTree in a recent note.

“In the long run, tax cuts could diminish the benefit of the corporate debt tax shield, decrease leverage and shift corporations away from debt, thus increasing the demand/cost of equity. However, given that legacy debt would likely be grandfathered in, these changes would occur only as previously issued debt rolled off/matured. In our view, this implies that corporate debt issuance could decline and aggregate credit quality could improve.” 

Investment-grade corporate bond ETFs have been prolific asset gatherers this year as investors are looking for conservative sources of yield beyond U.S. government debt. Two of the top asset-gathering bond ETFs this year are comprised of investment-grade corporates.

Spread Risk

WFIG has an effective duration of 7.4 years. Duration measures a bond's sensitivity to interest rate risk. In the case of high-grade corporate bonds, tax reform could shift the conversation away from interest rate and credit risk to spread risk.

“Credit spreads at the very highest rungs of the spectrum could shift to primarily become a function of liquidity risk in the bond market as opposed to credit risk,” said WisdomTree. “In our view, while a spread should exist between rating buckets, it is likely that you would see a meaningful parallel shift lower in credit spreads over time. Similarly, with less supply coming on to the market in the long run, it is also possible that bond market liquidity could actually improve despite current concerns to the contrary.”

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