IGSB - IGSB: Parking Your Cash Here Is Likely Not The Best Choice

2023-03-15 12:40:06 ET

Summary

• IGSB invests in short-term investment grade corporate bonds.
• The fund has delivered lower total returns in the long run than other longer duration bond funds in the same category.
• IGSB faces some downside risk in a market selloff.
• Given macroeconomic uncertainties in 2023, investors are better off to invest in funds that own solely U.S. treasuries.

Introduction

Given market uncertainties recently, some investors may wonder what is the best strategy to invest in bond funds right now as many of them have attractive yields. In this article, we will analyze iShares 1-5 Year Investment Grade Corporate Bond ETF ( IGSB ) and provide investors with our suggestions.

ETF Overview

IGSB focuses on short-term investment grade corporate bonds in the United States. Despite delivering negative returns in the past two years, the fund actually performed relatively better than its longer duration peers. However, the fund’s performance is inferior than its longer duration peers in the long run. Like its peers that own corporate bonds, the fund has downside risk if the market enters a panic mode. Given macroeconomic uncertainties in 2023, we think it is better to own funds that invest solely in U.S. treasuries. Therefore, we recommend investors to seek alternatives elsewhere.

Fund Analysis

IGSB delivered negative total returns in this bear market

The bond market has been in a decline since reaching the cyclical high in early 2021. IGSB has since declined as much as 12% from peak to trough. Thanks to the bond market rally in late 2022, it has recouped some of the losses but still lost nearly 9% of its value since 2021. Even if we include bond interest earned, the loss was nearly 6%.

But it still outperformed its intermediate and long-term bond peers

While IGSB has delivered negative returns since the beginning of 2021, its loss was limited as it only invests in short duration corporate bonds. In fact, the fund has a weighted average maturity year of 2.99 years. IGSB’s portfolio of short duration bonds means that the fund is less sensitive to rate changes than funds that own longer duration bonds. Therefore, IGSB’s loss was limited to single digit in the past two years. In contrast, other longer duration bond funds have suffered much greater losses. As can be seen from the chart below, iShares 5-10 Year Investment Grade Corporate Bond ETF ( IGIB ) and iShares 10+ Year Investment Grade Corporate Bond ETF ( IGLB ) endured losses of 18.34% and 30.56% respectively.

Investment grade quality portfolio

Almost all of IGSB’s portfolio consists of investment grade corporate bonds. While its yield is lower than non-investment grade bond funds, it also has lower credit risk. In fact, investment grade bonds’ default rate is only about 0.10% per year (based on 32-year period measured). On the other hand, default rate for below-investment-grade bonds is forty times higher! (about 4.22% per year). However, we noted that nearly 45% of its bonds are BBB rated bonds. These are the lowest investment grade bonds. In times of economic turmoil, some of these bonds may end up being downgraded to non-investment grade bonds and prices of these bonds may fall. Therefore, IGSB is more vulnerable than other investment grade bond funds that have higher proportion of A, AA, and AAA rated corporate bonds.

30-Day SEC yield is attractive

The decline in bond price last year has resulted in higher yield. In fact, IGSB’s 30-day SEC yield is now 5.38%. This is nearly 1 percentage higher than the 4.54% yield of iShares Short Treasury Bond ETF ( SHV ), which only invest in short-term U.S. treasuries.

But it still has some downside risk in a market selloff

Despite its higher yield than funds that own solely U.S. treasuries, IGSB has one important weakness that investors need to be aware of. During the time of a market panic, a negative spike may result in its fund price dropping. This is because investors tend to rotate their assets from slightly riskier corporate bonds to risk-free U.S. treasuries. As can be seen from the chart below, this negative spike is observed during the 2020 recession and 2008/2009 recession. Fortunately, this negative spike is not as severe as other longer duration bond funds. Based on its performance in the past two recessions, the downside risk is likely going to be less than 10%. This downside risk is much lower than equities. For example, the S&P 500 index declined by over 20% in 2020 and closer to 60% in 2008/2009.

Should you invest in IGSB?

It really depends on your purpose of owning this fund. For investors with a long-term investment horizon, this fund is not suitable for you as its total return is quite limited. In fact, it only generates a total return of 22.98% since 2010. In contrast, its longer duration peers IGIB and IGLB delivered total returns of 44.5% and 76.74% respectively.

For investors that only wish to park the money in IGSB temporarily and wait for the broader market to crash before rotating the money to equities, this fund may be an okay choice since downside risk is likely limited to within 10%. However, there are better choices available such as investing in short-term treasury funds as these funds have even lower downside risk.

Investor Takeaway

Although IGSB currently offers an attractive interest income with a yield north of 5%, this fund is not suitable to invest in the long run in my opinion. In addition, it is also not the best option to invest in the near-term given some downside risk. Therefore, we think investors should seek alternatives elsewhere.

Additional Disclosure : This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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