Exchange-traded funds tied to investment-grade corporate bonds have come back into favor this year, with the category seeing billions of dollars in inflows, even as analysts remain cautious about the group.
The iShares iBoxx $ Investment Grade Corporate Bond ETF /zigman2/quotes/206919681/composite LQD -0.63% , the largest ETF to track the space, has seen inflows of $2.46 billion thus far in 2017. To compare, the iShares equivalent for junk bonds, the iShares iBoxx $ High Yield Corporate Bond ETF /zigman2/quotes/204471305/composite HYG -0.90% , has seen outflows of $1.1 billion over that same period.
Among other widely used funds in the space, the Vanguard Short-Term Corporate Bond ETF /zigman2/quotes/208462329/composite VCSH -0.08% has seen inflows of $945.4 million year to date, while $1.95 billion has gone into the intermediate-term /zigman2/quotes/202884162/composite VCIT -0.24% fund.
Investment-grade bonds, which carry high credit ratings, underperformed their lower-rated, high-yield equivalents in 2016, with the divergence particularly acute after the November election of Donald Trump, whose policies are seen as better for riskier assets.
Investment-grade bonds are issued by companies that no matter how remote the risk is, could default on payments. They don’t have the government backing that U.S. Treasurys carry. Still, many high-rated company bonds are considered relatively low risk, as are government bonds. November was the worst month for Treasurys since December 2009.
That trend has continued thus far in 2017, with all three investment-grade bond ETFs up about 0.3%. To compare, the iShares high-yield bond fund is up 1.2%. The PIMCO 0-5 Year High Yield Corporate Bond Index ETF /zigman2/quotes/205210165/composite HYS -0.36% , which has seen outflows of $237.2 million year-to-date, is up 1% on the year.
Guggenheim on Thursday wrote that while yields for investment-grade bonds appeared more attractive than they did six months ago, analysts there continued to be cautious over the space.
“The prolonged period of low interest rates has facilitated investor willingness to accept weaker structural protections in exchange for yield. While this trend has existed for at least a couple of years already, it is beginning to garner real investor attention. The combination of weaker structures and hope-driven tightening in spreads heightens our concerns,” it wrote in a note to clients. “We believe spreads can grind tighter from current levels, but weaker structures and increased leverage are currently laying the groundwork for future downgrades.”
The firm said it was more constructive on junk bonds, though it cautioned that the recent rally may have gotten overdone. The iShares high-yield bond is up more than 14% over the past 12 months.
“Therefore, potential factors that could spook equity investors may also drive spread volatility in the high-yield [bond] sector,” Guggenheim analysts wrote. “Given that the market is already priced for a fundamental recovery, it may be vulnerable to disappointing economic data as well.”