VCLT - VCLT: Attractive Buying Opportunity For Long-Term Investors

2023-10-04 13:07:44 ET

Summary

• Vanguard Long-Term Corporate Bond ETF delivered negative returns in the past 2 years due to aggressive interest rate hikes by the Federal Reserve.
• The current yield of VCLT is attractive at 6.08%, making it a good time to accumulate shares.
• Investors should treat any negative spikes in VCLT's fund price as buying opportunities.

Introduction

I wrote an article back in June 2020 about the Vanguard Long-Term Corporate Bond ETF ( VCLT ). At that time, I stated that interest rate risk was minimal and it was okay to continue to own VCLT until 2022. The script played out quite well, and it was not until the first half of 2022 that the Federal Reserve started to raise its interest rates aggressively to combat sky-rocketing inflation. Now that the rate has risen so much and VCLT has fallen so much, I think it is time to re-visit this fund and provide my insights and recommendations.

ETF Overview

VCLT invests in long-term investment grade corporate bonds in the United States. The fund has not performed well in the past 2 years. While inflation appears to be persistent, I believe the Federal Reserve's monetary policy will eventually move inflation back to its long-term target of 2%. The problem is that it takes time. In the meanwhile, the Federal Reserve's aggressive monetary policy has caused VCLT's yield to move above 6%. This yield appears quite attractive. I believe this is a good time to accumulate shares of VCLT and average down on any fund price weaknesses. Over the long run, as the Federal Reserve eventually relaxes its monetary policy due to cooling inflation, VCLT's fund price will eventually move up and result in capital appreciation.

Fund Analysis

VCLT resumed its decline in Q3 2023

The bond market had a disastrous year in 2022. VCLT was not without exception. This was due the Federal Reserve's aggressive rate hikes to combat sky-rocketing inflation. The rebound towards the end of 2022 was short-lived as the fund resumed its declining trajectory in 2023. We know that long-term duration bonds are much more sensitive to rate changes than shorter duration bonds. VCLT's average duration of 12.9 years means that for every percentage point increase in rates, VCLT's fund would fall by about 12.9%. As can be seen from the chart below, its fund price declined from above $105 down to $69 in the past two years. This represented a decline of 38% from the peak in 2021.

Should investors start buying VCLT?

Given that VCLT has fallen so much from the peak, its current 30-day SEC yield is now 6.08%. This is quite attractive and we have not seen a rate as attractive as this for a long time. Since we may be closer to the end of this rate hike cycle than the beginning, one may wonder whether this is a good time to start buying VCLT. Here, we will provide a few points for readers to consider:

1. Combating inflation is not an easy task, and it will take time

Combating inflation is a difficult task. As inflation rises, workers typically demand higher wages. However, higher wages will result in higher labor expenses for goods and services. This will cause the prices of goods and services to rise. Workers will demand higher wages again in order to combat rising prices. As we can see, there is a spiraling effect, and it is difficult to control inflation. In fact, the Federal Reserve has indicated numerous times that this rate is only going to stay elevated or perhaps even higher for a lengthy time. The problem with higher rates is that bond prices will likely be suppressed.

2. Expect a negative spike to occur in VCLT's fund price in market turmoil

Investors of VCLT should understand that the market usually perceive corporate bonds as riskier assets than U.S. treasuries. Therefore, during any market selloff, corporate bond funds typically also fall sharply. As can be seen from the chart below, VCLT's fund price suffered a decline over 25% in the initial outbreak of COVID-19 in 2020 despite VCLT's high quality portfolio that consists of only investment-grade corporate bonds. In contrast, the Vanguard Long-Term Treasury ETF ( VGLT ) did not really suffer any negative spikes in 2020.

Looking forward, I believe an economic recession caused by the Federal Reserve's higher and for longer interest rate policy will eventually arrive in the first half of 2024. This economic recession will likely trigger a negative spike in VCLT's fund price. If we see this negative spike in VCLT's fund price, investors should not be fearful. As investment guru Warren Buffett often says, "Be greedy when others are fearful," long-term investors should see this possible negative spike as a great buying opportunity. As we have seen from past instances, these negative spikes are often short-lived and the fund price will likely soon return back to the normal price.

3. Long term investors may want to start accumulating

What should investors do in this macroeconomic uncertainty? If the goal is solely to receive interest income in the long run, we think this is a good time to start accumulating. Since we do not know where exactly the bottom is, I think the best strategy is to gradually accumulate shares of VCLT and be prepared to average down on any price weaknesses. Investors should especially take advantage of any negative spikes in its fund prices. Over the long run, if inflation slowly moves back down to the Federal Reserve's 2% target level, monetary policy should also be relaxed. This would result in higher fund prices for VCLT. Therefore, investors can potentially expect both capital appreciation and 6% interest income in the long run.

4. VCLT provides better long-term returns than treasuries

While treasuries may be safer in the near-term, their long-term returns trail investment-grade corporate bond funds. As we can see from the chart below, VCLT's long term return of 70.9% since its inception in late 2009 is actually much better than VGLT's 33.2%. Therefore, I think owning VCLT is better in the long run.

Investor Takeaway

For investors wishing to own a portfolio consists of investment-grade corporate bonds, VCLT is a nice choice. I believe now is a good time to accumulate shares for investors with a long-term investment horizon as the fund offers attractive yield and has the potential for capital appreciation in the long run.

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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