Valuation, Not Duration, Drives Performance in CorporatesWilliam Sokol, Senior ETF Product ManagerAugust 18, 2021
The indices tracked by the VanEck Vectors Moody’s Analytics IG Corporate Bond ETF (MIG) and VanEck Vectors Moody’s Analytics BBB Corporate Bond ETF (MBBB) have outperformed the broad investment grade corporate bond market as well as shorter duration segments of the market since the two ETFs launched in December 2020, as of July 31, 2021.1 Please see performance as of the most recent month end by clicking here for MIG and here for MBBB. Although their histories are still short, we believe they are performing as intended and demonstrate that investors can achieve better outcomes by being selective within corporate bonds. These indices are designed to select the most attractively valued bonds from the broader universe, and avoid bonds that are overpriced relative to their risk-adjusted “fair value” or bonds that are at a high risk of being downgraded to high yield.
With interest rates increasing sharply in the beginning of the year, all rate-sensitive asset classes were negatively impacted, particularly those with longer durations. With generally tight credit spreads and a longer overall duration than asset classes such as high yield, investment grade corporates were no exception.2 However, flows into corporate bonds have remained strong due to the incremental yield and relative safety the asset class provides.3 We believe that investors looking for yield pickup through corporate bonds should consider strategies that achieve this objective through greater exposure to spreads, rather than by adding duration, while controlling for risk. This means identifying bonds that provide a higher credit spread than their modelled fair value, meaning that investors are earning excess spread relative to the underlying risk of the bond.
Doing so has provided a performance benefit to investors since the two ETFs launched on December 1, 2020. Attractively valued investment grade bonds outperformed the broad investment grade market by 1.25% through 7/31/2021. Although this segment of the market has a somewhat shorter duration than the broad market, the vast majority of outperformance (approximately 80%) came from a greater benefit from credit spread tightening in the period. Sector and rating differences did not have a significant impact on relative performance. Similarly, attractively valued BBB rated bonds outperformed the broad BBB market by approximately 1.20%, driven by the same factors.4 Moreover, by segmenting the broad investment grade market by duration it is also clear that attractively valued bonds outperformed both the longer duration segment (despite having a lower average yield) and shorter duration bonds (despite rising interest rates over the period), as shown in the chart below.
Attractively Valued Bonds Have Outperformed the Broad Market and Both Longer and Shorter Duration Segments
12/1/2020 to 7/31/2021
Source: Morningstar as of 7/31/2021. Attractively Valued BBB Corporates is represented by MVIS Moody’s Analytics US BBB Corporate Bond Index; Attractively Valued IG Corporates is represented by MVIS Moody’s Analytics US Investment Grade Corporate Bond Index; Broad BBB Corporates represented by ICE BofA BBB US Corporate Index; Intermediate Duration Corporates represented by ICE Bofa 1-10 Year US Corporate Bond Index; Broad IG Corporates represented by ICE BofA US Corporate Index; Long Duration IG Corporates represented by ICE Bofa 10+ Year US Corporate Bond Index; Short Duration IG Corporates represented by ICE Bofa 1-3 Year US Corporate Bond Index.
The outperformance of attractively valued bonds against both longer and shorter duration segments may help dispel concerns that investment grade corporate bonds are simply a play on interest rates, which may keep certain investors on the sidelines in this rate environment. By maintaining exposure to bonds with high excess spread relative to fair value, there is more room for spread tightening among attractively valued bonds. Because only bonds with high excess spread are selected, and bonds are removed as they converge towards fair value, there is a potential to consistently benefit from market mispricing of risk, despite currently low levels of interest rates, through monthly rebalancing.
Although there is certainly a place for higher yielding asset classes such as high yield bonds, emerging markets debt and even equity income strategies within an overall income-oriented portfolio, we believe a core bond allocation should provide income and relative safety. The key to achieve potential outperformance in corporate bonds is to accurately identify risk so that attractive value can be identified. Our strategies rely on proprietary credit risk metrics developed by Moody’s Analytics. More information on the methodology can be found in this whitepaper and this video, and additional resources can be found here.
MVIS Moody’s Analytics US BBB Corporate Bond Index includes investment grade corporate bonds that have attractive valuations and a lower probability of being downgraded to high yield compared to other investment grade bonds.
MVIS Moody’s Analytics US Investment Grade Corporate Bond Index includes BBB rated corporate bonds that have attractive valuations and a lower probability of being downgraded to high yield compared to other investment grade bonds.
ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.
ICE BofA BBB US Corporate Index is a subset of the ICE BofA US Corporate Index comprised of bonds BBB ratings.
ICE Bofa 1-10 Year US Corporate Bond Index is a subset of the ICE BofA US Corporate Index comprised of bonds with a final maturity less than 10 years.
ICE Bofa 10+ Year US Corporate Bond Index is a subset of the ICE BofA US Corporate Index comprised of bonds with a final maturity greater than 10 years.
ICE Bofa 1-3 Year US Corporate Bond Index is a subset of the ICE BofA US Corporate Index comprised of bonds with a final maturity less than 3 years.
1 Source: Morningstar, from 12/12020 to 7/31/2021. The broad investment grade corporate bond market is represented by the ICE BofA US Corporate Index for broad corporate bonds; ICE BofA BBB US Corporate Index for broad BBB market; and ICE Bofa 1-3 Year US Corporate Bond Index, ICE Bofa 1-5 Year US Corporate Bond Index, and ICE Bofa 1-10 Year US Corporate Bond Index for shorter duration segments of the corporate bond market.
VanEck Vectors® Moody’s Analytics® IG Corporate Bond ETF seeks to track, as closely as possible, before fees and expenses, the price and yield performance of the MVIS® Moody’s Analytics® US Investment Grade Corporate Bond Index, which includes investment grade corporate bonds that have attractive valuations and a lower probability of being downgraded to high yield compared to other investment grade bonds.
VanEck Vectors® Moody’s Analytics® BBB Corporate Bond ETF seeks to track, as closely as possible, before fees and expenses, the price and yield performance of the MVIS® Moody’s Analytics® US BBB Corporate Bond Index, which includes BBB rated corporate bonds that have attractive valuations and a lower probability of being downgraded to high yield compared to other BBB rated bonds.
2 Source: ICE Data Indices.
3 Source: Morningstar, as measured by flows U.S. mutual fund and ETFs in the Corporate Bond, Intermediate Core and Intermediate Core-Plus categories from December 2020 through June 2021.
4 Source: FactSet as of 7/31/2021.
Past performance is not a guarantee of future results. Please call 800.826.2333 or visit vaneck.com for performance current to the most recent month ended.
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Authored byWilliam Sokol
Senior ETF Product Manager