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Published: July 14, 2010
Talk about some serious volatility.
The past two years have been some of the most hectic ever -- on
both the downside and the upside. Meanwhile, if you're trying to
escape the ups and downs in some of the typical safe-haven
investments, you're being paid next to nothing.
One-year
CDs pay a little over 1% a year. Three-year CDs pay less
than 2% annually. Not even accounting for taxes or
inflation, a one-year CD would take 61 years to double your
money at these rates.
You might think there's nowhere to earn a solid return if you
can't stomach a volatile market. But I've found an answer -- the
opportunity in high-quality bonds.
Specifically, I'm talking about investment-grade corporate
bonds; those with credit ratings of "BBB" or higher by Standard
and Poor's. The average credit spread (the difference in
yield versus 10-year Treasuries) for investment-grade bonds
as a whole is at about 240 basis points, which is well above the
historical average of 151 basis points.
Their high credit ratings indicate a strong ability to pay debt
and thus, lower risk. Yet, the higher-than-usual spread
indicates it might be a decent time to buy for risk-averse
investors. In particular, I've been looking at one specific
fund.
The iShares iBoxx $ Invest Grade Corp Bond Fund (NYSE: LQD)
is an exchange-traded fund that invests in a diversified
portfolio of investment-grade corporate bonds.
LQD is a great way to play investment-grade bonds for a couple
of reasons. First, since the
ETF invests in a broad and
diversified portfolio (474 issues as of July 12th), it
eliminates the risk associated with holding a small group of
issues. Second, the fund trades on the NYSE, offering ample
liquidity. The fund can be bought or sold at any time the market
is open.
Another huge bonus of this fund is that it pays distributions
every single month (unlike individual bonds, which typically pay
interest twice per year). The last distribution was $0.44 per
share, and the past year's distributions have totaled $5.53 per
share for a solid trailing yield of about 5%.
LQD's average overall
credit rating is "BBB+," two steps above "junk" status. Its
largest sector holdings are banks, telecom, and oil and gas
producers. Top holdings include the debt of well-known names
like Verizon (NYSE: VZ), Wells Fargo (NYSE: WFC)
and Walmart (NYSE: WMT).
The performance of LQD has endeared it to investors as a
safe-haven investment. In the past three years, while the S&P
500 has returned -9.9% annually, the fund has posted an average
annual total return of +7.0%. In fact, LQD actually had positive
total returns in 2008 -- during the bulk of the market crash.
And most recently, while the S&P 500 fell sharply between late
April and early July, LQD actually increased in price as
investors flooded to its safety.
While the performance has been great,
bonds still have a glaring vulnerability... interest rates.
As rates rise, bond prices fall. So far, the Federal Reserve has
kept interest rates at rock-bottom levels in order to stimulate
the economy. That means rates have just about nowhere to go but
up. Many contend that the Fed may have to raise rates
significantly in the future in order to fight inflationary
pressures created by skyrocketing debt and deficits.
To combat this, LQD has relatively short-term exposure -- more
than 70% of the portfolio matures in less than ten years (26% in
less than five years). This makes the fund less vulnerable to
rising interest rates than longer-term funds since it can
reinvest the funds from maturing bonds into newer issues with
higher rates.
Rising rates, however, might be still be well into the future as
the recovery appears to be sputtering.
Housing starts, a key leading indicator, fell -10% in May (a
five-month low) and private sector job creation continues to be
below the amount needed just to hire new workers entering the
workforce. In fact, just last month the Commerce Department
lowered its first quarter U.S.
GDP growth forecast to +2.7% from a previous +3%. In the
face of these results, the Fed continues to say it will hold
rates low for "an extended period."
Action to Take -->
Risk-averse investors can buy LQD here as it should continue to
provide a relatively secure investment that pays a solid yield.
While the price is near a 52-week high, its quality portfolio
and plenty of nervous investors should support the fund price
for the foreseeable future.
-- Tom Hutchinson
Staff Writer
StreetAuthority |
