BND - PULS: High Yield Low Risk And Potential Capital Appreciation

2023-06-23 10:30:03 ET

Summary

• The PGIM Ultra Short Bond ETF offers a safe investment option with a high yield of 4.9% for investors expecting a recession.
• PULS has a diverse portfolio of high-quality short-term bonds, with 75% of its holdings in A-rated bonds or better.
• PULS has advantages over other ETFs, such as potential for capital appreciation and less reinvestment risk, making it a recommended Buy.

The PGIM Ultra Short Bond ETF ( PULS ) invests in high-quality short-term bonds. With AUM of about $4.5B, PULS has an SEC 30-day yield of almost 5%. This actively managed fund aims to provide investors with income as well as the chance to profit from capital appreciation. This safe ETF is great for investors who are expecting a recession and looking for an asset that provides capital preservation and a high yield. I rate PULS a Buy.

Holdings

PULS holds 516 bonds issued by the US government, US-domiciled corporations, and foreign entities. These holdings are chosen by using "a combination of top-down economic analysis and bottom-up research in conjunction with proprietary quantitative models and risk management systems to manage the fund's assets." PULS's top 10 holdings make up about 7% of its AUM.

PULS holds bonds from a diverse group of issuers. As the image below shows, no one issuer is responsible for over 1.5% of PULS's AUM.

PULS also has good diversification among sectors, with the largest sector being corporate bonds, making up about 31% of this ETF.

This ETF is 45% <1-year bonds, 53% 1-3 year bonds, and the small remaining amount is in 3-5 year bonds.

Because of the short maturity time, these assets are lower risk. However, there is another factor that causes PULS to be an ultra-low risk, which is that almost 35% of this ETF is in AAA-rated bonds, the highest possible credit rating. About 75% of its holdings are in A-rated bonds or better. The higher the rating quality, the lower the risk.

Yield

The Fed has raised rates to a 2-decade high . This has given short-term bonds very attractive yields. PULS currently boasts an impressive 30-day SEC yield of 4.9%. Because of the inverted yield curve, short-term bond ETFs are paying more than many longer-term bond ETFs.

PULS has a higher yield than both BND and VTC. However, because PULS is a short-term bond ETF and BND and VTC aren't, PULS also has less risk. The chart below shows the total return of the ETFs and illustrates how much more volatile BND and VTC are compared to PULS.

In this case, the tradeoff for higher risk is lower yield. That is not fair trade.

SGOV, a popular 0-3 month ultra-short-term treasury bond ETF, does have a slightly higher yield than PULS. Both these ETFs have limited risk. Government treasuries are very safe, and so are top credit-rated bonds.

Although SGOV's yield is almost 0.2% more, I think PULS has some advantages over SGOV.

PULS vs SGOV

One of the biggest advantages of PULS is that it has a slightly higher risk, giving it more capital appreciation potential. Because SGOV's holdings are so short-term and safe, the ETF doesn't have much change in price; only the yield changes. While PULS's holdings are by no means high risk, they are riskier than SGOV's due to the longer maturity time as well as its holdings of corporate bonds. The chart below shows the past 3-year total return of these two ETFs. PULS is clearly more volatile.

The higher risk has already played in PULS's favor, causing it to outperform SGOV in the last 3 years, but I think looking forward it is likely to benefit PULS even more.

As all bond investors know, as rates fall, bond prices go up. After Fed Chairman Powell's last announcement, we learned a lot about what interest rates will likely do in the near future. One of the most important announcements was that there will likely be only 2 more rate hikes in 2023. We also know that there will be a couple of years before rates are cut. When rates fall, SGOV's yield will go down, and it will experience minimal capital appreciation, whereas PULS will experience much more capital appreciation. PULS allows you to take advantage of the high short-term rates, while also having the potential for capital appreciation.

Another benefit of PULS is that it has lower reinvestment risk than SGOV. When rates fall, after 3 months, all of the high-yield treasuries will be out of the fund, and they will be replaced by new treasuries with the new lower yield. Because over 50% of PULS is in 1-3 year bonds, the higher rates will be locked in longer.

Risks

The main reason I'm recommending this ETF is because I expect a recession in the near future. Since 2000, every time we have has a rapid rise in interest rates, it has led to a recession. The chart below shows the Fed fund rate and the gray bars are recessions.

I don't expect this time to be any different. During economic turmoil, bond default rates go up. This could potentially hurt PULS. However, considering that most of PULS is in AA bonds or higher, I don't think this is a major problem. 98.96% of AAA and AA-rated " corporate bonds have generated coupon payments and redemptions as promised over the past 40 years without a single missed or even late payment." In addition, if rates end up going higher than the Fed currently anticipates, this would cause the value of PULS to decline.

Conclusion

PULS offers exposure to highly rated short-term bonds. PULS is less volatile than BND and VTC and has a higher yield. While SGOV has a slightly higher yield than PULS, because PULS has the chance of capital appreciation as well as having lower reinvestment risk, I prefer PULS. Finally, as we head into a recession and bond defaults start to increase, the highly rated bonds PULS holds limit some of that risk compared to BND and VTC. I rate PULS a Buy.

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