SPSB - SPSB: Earn 5.66% With No Headaches

2023-09-13 18:57:43 ET

Summary

• The SPDR Portfolio Short Term Corporate Bond ETF is a fixed income ETF that tracks the Bloomberg U.S. 1-3 Year Corporate Bond Index.
• SPSB offers a short-term investment grade bond play with added corporate credit spreads, providing exposure to both duration and credit spread risk.
• The fund has a granular portfolio with over 1400 names, mitigating the risk of a renewed regional banking flare-up.
• The fund has a balanced composition, with over 45% of the collateral pool in single-A rated names.

Thesis

The SPDR Portfolio Short Term Corporate Bond ETF ( SPSB ) is a fixed income exchange traded fund. The vehicle has no leverage, and as per its literature:

seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Bloomberg U.S. 1-3 Year Corporate Bond Index (the "Index")

We are going to discuss in detail the Bloomberg U.S. 1-3 Year Corporate Bond Index in a section below, but suffice to say for now that the respective index tracks short-dated investment grade bonds issued by U.S. corporates.

The best way to think about SPSB is as the investment grade bond vehicle that is complementary to the iShares 1-3 Year Treasury Bond ETF ( SHY ). We covered SHY here , and the two vehicles have very similar duration profiles:

SHY is composed of treasuries only, and represents a pure rates play. SPSB has an added layer of corporate credit spreads (80 bps options adjusted spread), and represents a short-term investment grade bond play.

The fund is not a cash parking vehicle such as the iShares Short Maturity Bond ETF ( NEAR ) or the PIMCO Enhanced Short Maturity Active Exchange-Traded Fund ETF ( MINT ). As we can see from the above table, those funds have an extremely short duration profile and thus their rates sensitivity is very low. Similarly, their credit spread sensitivity is muted given the duration profile.

Not for SPSB. With this fund an investor is taking a bit of both duration and credit spread risk. Investment-grade corporate balance sheets are in great shape currently, and two-year probabilities of default are fairly low, so we would like to think of SPSB as a smart way to take short-term rates and credit exposure.

Analytics

• AUM: $7.3 billion.
• Sharpe Ratio: -0.98 (3Y).
• Std. Deviation: 2.14 (3Y).
• Yield: 5.66% (30-day SEC yield).
• Portfolio Yield: 5.89%.
• Premium/Discount to NAV: N/A.
• Z-Stat: N/A.
• Leverage Ratio: 0%.
• Composition: Fixed Income - Short Duration IG Bonds.
• Duration: 1.8 yrs.
• Expense Ratio: 0.04%.

The Bloomberg U.S. 1-3 Year Corporate Bond Index

In this section we are going to have a closer look at the corporate bond index the ETF tracks, its composition and analytics. As per its literature:

The Bloomberg U.S. 1-3 Year Corporate Bond Index (the "Index") is designed to measure the performance of the short-term U.S. corporate bond market. The Index includes publicly issued U.S. dollar denominated corporate issues that have a remaining maturity of greater than or equal to 1 year and less than 3 years, are rated investment grade (must be Baa3/BBB- or higher), and have $300 million or more of outstanding face value. In addition, the securities must be denominated in U.S. dollars, fixed rate and non-convertible. The Index includes only corporate sectors. The corporate sectors are Industrial, Utility, and Financial Institutions, which include both U.S. and non-U.S. corporations.

Please keep in mind that duration is not the same as a maturity date, thus although the bonds in the index are all with a maximum maturity of 3 years, this actually translates into a portfolio duration closer to 2 years, which is what we see in the ETF tracking the index. The index looks for liquidity in the underlying bonds via the minimum $300 million outstanding notional for the bonds being included, with most of the names coming from the Industrial, Utility and Financial Institutions sectors.

Fund Holdings

Currently, industrials make up most of the fund holdings:

We can notice that utility bonds are almost absent presently from the fund composition, while the rest of the ETF contains mostly financial services names.

One of the concerns expressed by some market participants is regarding financials, and the potential repeat of the regional banking crisis that saw a couple of names in the space (and their senior unsecured debentures) completely wiped out after the regulators took over the institutions. This fund mitigates that risk by having an extremely granular portfolio that contains over 1400 names, with each issuer having a very low overall weighting in the fund:

We can see the top names in the vehicle all being under a 0.5% holdings threshold. While we would have been concerned about Credit Suisse in March, it is no longer the case currently. Also, if we go through the math of a default here, the net carry drag is fairly muted.

Let us take an example. Let us theoretically assume Oracle defaults. Looking at historic recovery rates for senior unsecured bonds, we get a 40% recovery rate here. Therefore, the net loss for the fund is 0.33% x (1-40%), which equals 0.198%. And this is for one of the top holdings in the fund. The lower we go in the collateral pool, the lesser the impact to the fund's carry profile.

While we acknowledge there is binary risk here if another regional banking crisis unfolds, we are of the opinion that the fund is granular enough to absorb a couple of restructurings.

From a ratings standpoint, the fund is very well-balanced:

Very aggressive funds have their collateral pool entirely made up of BBB credits. Not here. There is a very sizable bucket of single-A credits, a bucket which represents over 45% of the collateral pool. This represents a defensive build for the fund, via a better credit rating profile. This profile will translate to shallower drawdowns if we have a credit spread event.

Performance

The fund's 1-year total return profile clearly highlights its duration drag as rates have moved higher:

While MINT and NEAR have acted as cash parking vehicles with nice, upward-sloping total return lines, SPSB and SHY have been hampered by their duration profiles.

This is set to change in 2024, when cuts in rates will boost SPSB's returns, with the fund set to make an incremental 2% if short rates move down by 100 bps. Currently, if rates stay put, the fund will accrete a 5.66% carry that will slowly move up toward the portfolio yield of 5.89%.

Conclusion

SPSB is a fixed income exchange traded fund. The vehicle targets the short end of the curve with a 1.8 years duration, and is composed of investment-grade corporate bonds. The fund is not overly aggressive in its credit build, with over 45% of its holdings in single-A credits, while the rest are kept in BBB names.

The best way to think about SPSB is as the investment-grade corporate alternative to the popular treasuries ETF SHY. SPSB contains credit spread risk in addition to rates, with the fund having an 80 bps options adjusted spread.

SPSB is not a cash parking vehicle, but a short-dated corporate bond fund that will deliver on its duration profile once rates start moving down in 2024. We found SHY to be attractive at this stage of the cycle, and similarly, we think SPSB is doing a good job of mitigating credit risks via its build. We like this name for a 7% total return in the next 12 months, stemming from its dividend yield and positive kick from its duration profile in 2024.

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