Saturday, April 4, 2009

Volume 3, Issue #25

Also in Today's Issue...

State Street has just launched the newest fund -- SPDR Barclays Long Term Credit Bond (LWC) -- aimed specifically at investment-grade corporate bonds. Linked to the Barclay's U.S. Long Credit Index, it will track the performance of debt issued by reliable companies like AT&T, Boeing, Target and Kraft. The portfolio contains a representative sampling of about 60 holdings overall, pulled mostly from the industrial and utility sectors.

LWC is billed as having the longest maturity of any corporate bond ETF on the market. And the latest specs show a modified duration of 10.6 years and an average maturity of 23.5 years. In fact, most of the bonds in the portfolio aren't scheduled to mature until 2030 or later.

As you might expect, longer-term bonds tend to offer better rates than shorter-term bonds of similar credit quality. And the fund's underlying index sports an overall yield to maturity of +8.1% -- about double the payout from high-grade corporate bonds at the short-end of the yield curve.

However, those higher rates also carry greater risks, as longer-term bonds are much more sensitive to interest rate fluctuations. A couple half-point rate hikes might not mean much to a 3-month Treasury, but they could lead to a double-digit decline in this portfolio.

Of course, corporate bonds have already been beaten up over the past year -- collateral damage from the subprime meltdown and frozen credit markets. But as we discussed last month, unless default rates eclipse those from the Great Depression, valuations look highly attractive at this point and yield spreads are off the charts.

Sensing the worst is over, investors are already becoming hungrier for stronger yields. In fact, State Street alone has reported more than $800 million in net cash inflows over the past two months into its 15 bond funds.

Unless the economy takes a dramatic turn for the worse, trading should stabilize and bond yields should revert to the mean. Under that scenario, long-dated investment grade credit could actually outperform stocks over the next few years. And a supply shortage can do nothing but help. According to T. Rowe Price, the issuance of new investment-grade credit has tumbled nearly -30% over the past six months.

LWC looks to be a natural beneficiary of all this. The fund wasn't the first ETF to test these waters -- iShares iBoxx Investment Grade Corporate Bond (NYSE: LQD) has been around for years. But LWC offers a higher yield and much less exposure to the financial sector.

Not that long ago we were celebrating the introduction of the very first bond ETF's. Now, they account for roughly half of all new fund launches. I can almost guarantee you there will be more bond funds to come, as issuers adjust their menus to meet the fickle tastes of investors.

Ordinarily, I would be hesitant to invest at the long-end of the yield curve under these conditions. With interest rates sitting near historic lows, they really have nowhere to go but up. However, I see minimal threat of a rate hike in the near future, as it would undermine any attempts to revive the feeble economy.
 

Good Investing,

-- Nathan Slaughter
Editor
The ETF Authority

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