Better Coverage With This Corporate Bond ETF

Corporate bonds, including those at the lower end of the investment-grade spectrum, are experiencing some tumultuous times.

The current environment for corporate bonds may compel investors to place increased emphasis on fundamentals, a strategy accessible via the WisdomTree Fundamental U.S. Corporate Bond Fund WFIG.

What Happened

Traditional corporate bond exchange traded funds are cap-weighted, but WFIG takes a different approach. WFIG's underlying index, the WisdomTree Fundamental Corporate Bond Index (WFCIG), uses a multi-tiered screening approach to find corporate debt with favorable fundamentals as well as strong income-generating potential.

WFIG's methodology includes screen for leverage ratios, coverage ratios, profitability and banking quality traits, according to WisdomTree.

Why It's Important

With nearly half the U.S. investment-grade corporate bond market sporting BBB ratings, meaning those bonds are just one to three notches above junk territory, leverage ratios are taking on added importance.

“The total leverage ratio for the WisdomTree Fundamental U.S. Corporate Bond Index (WFCIG) is only 2.56x while the total leverage ratio for the market-cap index is 3.28x,” said WisdomTree.

About two-thirds of WFIG's holdings carry BBB ratings, but the fund's holdings within that ratings spectrum are less levered than in comparable benchmarks.

“Notice the total leverage for BBBs in WFCIG is only 2.87x compared to 3.40x in the market-cap index. When examining leverage through other lenses such as net debt to EBITDA or debt to assets, similar patterns emerge,” according to WisdomTree.

What's Next

If interest rates continue climbing, another ratio, interest coverage ratio, will also receive renewed attention. WFIG offers some comfort on that front as well.

“In terms of interest coverage ratios, a common rule of thumb is for businesses in most industries to maintain a comfortable cushion of at least 3.5x EBIT to interest expense,” said WisdomTree. “While market-cap-weighted approaches currently pass with coverage in excess of 5x, our fundamental approach sports a near 40% improvement in interest coverage ratios.”

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