BILS - SLQD: Why We Prefer BILS Here

Summary

• SLQD offered a very poor return profile when we last covered it.
• Things have improved materially and you are now getting paid to buy the fund.
• We still prefer BILS for shorter term yield as we don't agree with what the markets are telegraphing.

iShares 0-5 Year Investment Grade Corporate Bond ETF ( SLQD ) invests in USD denominated, investment grade corporate bonds maturing is less than five years. When we last covered this ETF, it was a popular cash parking vehicle for investors focused on the 12 month trailing yield instead of what the portfolio was earning at the time. We are talking 2020 here, when the trailing yields painted a more rosy yield picture. We are in 2023 now and the opposite is true. We left this one with a neutral rating back then, choosing to avoid the duration risk that came with this "cash parking" opportunity.

Until we see a break in the interest rates out there, we still think a high interest savings account or even a blue minivan would be better to park your cash. We prefer Cash Secured Puts because they give us high double digit yields for buying stocks we want to own, at the price we want to own them at.

Source: Blink Twice If You Know Its Real Yield

Investors that did not blink, also did not make the 2% plus on this cash parking opportunity as they had hoped.

We are now in a different interest rate era and reevaluate this fund in light of that.

Fund Setup

The fund has most of its holdings in the middle of the investment grade spectrum with A and BBB rated making up 90% of the total.

We do see some BB rated holdings and those likely came about as a result of a downgrade while the fund was holding an investment grade security. There is no urgent mandate built in to sell these and the fund can hold these to maturity. Generally, the first layer of junk bonds are quite safe from default over short timeframes and we would not expect this to impact returns.

For those wondering, the fund does stick to the shorter timeframes and almost two-thirds of the fund holdings mature in under 3 years.

Risks & Rewards

The fund gives you a one stop diversified entry into all things investment grade. With 2,256 holdings you are really not betting even the barn door, let alone the farm, on any one company.

The weighted duration is also not very long at 2.2 years. With the extremely low interest rates in play during late 2021, even this duration presented a risk. But today, you should have no fear of material duration risk for this fund.

The fee structure is extremely modest and gets one up on James Bond.

So all of this looks good and if you want some bonds in your portfolio this is a good place to look.

Why We Would Consider Bloomberg Barclays 3-12 Month T-Bill ETF ( BILS ) Instead

BILS is a relatively new fund and has about three quarters of a billion in total assets. The fund sticks to Treasuries and occupies a sweet spot in our opinion.

The SPDR Bloomberg 3-12 Month T-Bill ETF seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Bloomberg 3-12 Month U.S. Treasury Bill Index (the "Index")

Seeks to provide exposure to publicly issued U.S. Treasury Bills that have remaining maturities between 3 and 12 months

Source: State Street

With 3-12 month treasuries, you are getting the best of the Fed rate hikes and the highest rates on the treasury curve. BILS has a yield to maturity of 4.66% and with an expense ratio of 0.135%, you are getting close to 4.52% today.

This is much better than what you are seeing further down the curve, thanks to epic levels of inversion. Below we have shown the 7, 10 and 20 year treasury rates.

So you are getting 4.66% from risk-free (or about as risk free as things get in this world) assets with no duration risk. On the other hand, SLQD gets you a SEC yield of 4.84% with mild duration and mild credit risk. That 18 basis points of extra you get from SLQD seems almost not worth it. Why would you take on that extra risk for a tiny amount more? The reason is that the current futures curve is pricing in some big rate cutting down the line.

The current perception is that the economy will weaken and the Federal Reserve will cut aggressively. If that turns out to be true, the yield on BILS will drop as the year progresses. So what the market is saying is that, while you are getting almost the same yield on SLQD and BILS today, you will get a lot more total return if you held SLQD over 3 years.

Our Thinking

The choice between these two comes down to how you see things evolving. If you believe the Federal Reserve will start cutting rates aggressively on economic weakness and credit spreads will generally not widen, then SLQD makes sense. We disagree with both points here. The first being that we think inflation will be a bit sticky and the Federal Reserve will hesitate to be aggressive in delivering rate cuts on a tight labor market. We see this as likely even if we have economic weakness. If we are incorrect about that and rate cuts come in fast and furious, we think credit spreads will blow out everywhere, including on the short side of the investment grade curve. Again, you don't want to own SLQD before that happens. At present we think BILS offers an extremely good alternative to SLQD and we would wait for the aforementioned credit event to dive into SLQD.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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