Uncover Hidden Value in Credit
February 05, 2021
Watch Time 8:45 MIN
Todd Rosenbluth: Hi, everyone. Welcome to today's fast chat as we uncover hidden value in credit. I'm Todd Rosenbluth, head of ETF and Mutual Fund Research at CFRA and a contributor at WealthManagement.com. Joining me is Bill Sokol, who's a Senior Product Manager of ETFs with VanEck. Welcome, Bill.
Bill Sokol: Hi, Todd. Thanks for having me.
Todd Rosenbluth: My pleasure. You launched a couple of fixed-income ETFs, MIG and MBBB. Can you describe the methodologies of these ETFs?
Bill Sokol: Yeah, of course. We're excited to have launched these two new ETFs, VanEck Vectors Moody's Analytics IG Corporate Bond ETFs, and that's MIG, and the VanEck Vectors Moody's Analytics BBB Corporate Bond ETF, that's MBBB. Both have similar approaches. Both aim to provide exposure to the most attractively valued bonds from within the corporate bond universe. In the case of MIG, that's the broad investment grade space, and then MBBB, that focuses on the BBB rated segment of the universe. Both use proprietary credit risk metrics developed by Moody's Analytics to select bonds. These metrics are based on market information, including a issuer stock price that's used to develop a forward-looking probability of default and fair value assessment.
Bill Sokol: The index provider uses these metrics to select bonds by looking at bonds that have a high spread relative to the embedded credit risk of these bonds. Or, in other words, bonds that provide the most attractive compensation relative to their risk. That translates into downside protection in the sense that you're avoiding bonds that have increasing levels of default risk or an increasing chance of being downgraded to high yield, as well as upside potential as the market converges towards fair value.
Todd Rosenbluth: I want to just drill back again about the problems that this can solve from a risk mitigation standpoint. What's most appealing to you about these two ETFs?
Bill Sokol: Well, we know that right now, investors need yield. We're in this environment where the Fed has effectively said that rates are going to be near zero for the foreseeable future. What's happened is that many investors have increased exposure to asset classes like high yield, EM debt, even equity income in their income portfolios. We think there's a lot of value in those asset classes, but they don't come without additional risks, of course. That could primarily mean additional credit risk. It also means that income portfolios will correlate more highly to equity exposures.
Bill Sokol: We think that the core portion of a bond portfolio should do two things. It should provide income, but it should also help to diversify against these riskier exposures, including equities. Historically, many investors have achieved that through going further out on the yield curve, so taking an additional interest rate risk. We think that these strategies can be attractive in the sense that they can provide the attractive yield potential that corporate credit can provide, but without having to take excessive credit risk or rate risk and by getting that upside potential.
Bill Sokol: First of all, both strategies provide higher credit spreads versus a broad-based exposure. That translates into a higher overall yield, but it's through higher credit spreads rather than longer duration. We know that, historically, credit spreads do diversify against interest rate risk. Second of all, you get that upside potential that I mentioned earlier. That's because we're selecting bonds that have the highest spread relative to risk, so as the market converges to fair value, you hope to see that upside potential. Because these ETFs track indices that rebalanced monthly, it means that you're buying bonds as these market opportunities arise, and you're selling bonds as these opportunities are realized.
Todd Rosenbluth: I wanted to come back to a couple of points you touched on, but there's a lot of investment grade corporate bond ETFs in the marketplace, and they've been pretty popular in 2020 as investors have search for income. What do you think makes these two products different than the alternatives that are [inaudible 00:04:35]?
Bill Sokol: When we launched these, we knew that investors have many options to choose from right now in investment grade corporate bonds from broad-based beta exposure, to smart beta, to actively managed strategies. Our research found that investors can achieve better outcomes by being selective in the investment grade corporate bond space. That means, in this case, choosing the most attractively valued bond. Doing so, historically, has provided higher risk adjusted returns and higher spread per unit of risk, versus what you would get with a broad-based exposure. Of course, many active strategies attempt to do exactly that. But we also know that active strategies have tended to underperform passive and come with a higher fee.
Bill Sokol: Other strategies might try to select bonds based on more of a fundamental approach, perhaps by screening based on ratios from the balance sheet or the income statement. But these tend to be more backwards looking, and they don't really listen to what the market is saying that something is worth.
Bill Sokol: Our approach is a little different in that it's purely quantitative, it's market informed, and it is based on a forward-looking assessment of risk and of fair value. The process is really driven by the industry's leading credit risk model from Moody's Analytics. It's a model that is backed by decades of research, a very extensive data set of global bond default and recovery data. That's the reason why hundreds of the world's largest institutional investors globally rely on Moody's Analytics to power their credit risk and portfolio management decision making. With MIG and MBBB, we wanted to bring that expertise to the ETF market through a low-cost, rules-based approach that allows investors to maintain and achieve an attractive yield and upside potential, but without having to take excessive risks within their core bond portfolios.
Todd Rosenbluth: That's great, Bill. This is really interesting to be able to learn about a market-informed risk mitigation investment-grade corporate bonds suite of products. Thanks for taking time to talk to us and for joining us for this fast chat. Thank you to the audience for listening. Tune in to WealthManagement.com for more conversations. Have a great day.
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