VCSH - VCSH Could Be A Good Place To 'Park Cash'

2023-09-12 14:36:45 ET

Summary

• Vanguard Short-Term Corporate Bond Index Fund ETF Shares is a good option for investors looking to park their cash temporarily in a low-risk vehicle.
• The fund invests in a well-diversified basket of almost 2,500 corporate bonds with an average yield of 5.5% and average duration of 2.7 years.
• The fund's holdings are mostly rated AA, A, or BBB, with a low risk of default, and the majority of the bonds will mature within 1 to 4 years.
• Due to its short-term nature, it is a lot less volatile than your average bond fund, not to mention long term funds like TLT.

Vanguard Short-Term Corporate Bond Index Fund ETF Shares ( VCSH ) is a bond fund that focuses on short term corporate bonds as the name implies. I believe this fund can be a good place for investors to park their cash if they have money on the sidelines waiting to be invested somewhere. In investing world, "parking cash" refers to investors putting aside a portion of all of their money temporarily into a low-risk vehicle while trying to decide where to invest.

This usually happens when investors believe the market is overvalued, overbought or simply not offering the best risk-reward balance so they decide to wait it out while earnings a non-zero return during this time at relatively low risk. Many investors prefer short term government bonds or money market funds for this purpose. I believe VCSH can be a pretty good place to park your money if you have cash on the sidelines waiting for a better entry point for the stock market.

The fund invests in a well-diversified basket of almost 2,500 corporate bonds with an average yield of 5.5% and average duration of 2.7 years. Keep in mind that the fund's holdings' average coupon is only 3.6% as compared but the average yield because of how much bond prices dropped in the last year and half as the Fed hiked short-term rates from virtually 0% to 5.5% which was one of the fastest rate hikes in history. The fund has a high turnover rate of almost 50% but this shouldn't scare you since most of the bonds it holds are short-term and it's quite natural for this fund to have a high turnover rate as its bond holdings keep reaching maturity and it keeps replacing those matured bonds with fresh ones.

The fund's holdings are mostly rated either AA, A or BBB with the last two accounting for about 90% of the fund's total weight. They are all investment grade and risk of default is very low especially considering most of these bonds will mature in the next couple years. Since the fund invests into close to 2,500 bonds, it would take a lot of default events (likely at last 100+) to actually cause any real damage to the fund and this is very rare unless the economy is in a really and severe deep trouble.

Only about 6.6% of the fund's holdings will have maturity duration over 5 years. The vast majority of the bonds in this fund will mature somewhere between 1 and 4 years. Short duration generally means less risk of default (holding everything else constant) and higher likelihood of getting paid.

Since the fund has so many holdings, even its top holding only accounts for 0.22% of its total weight. It's top holdings include bonds from many familiar companies such as Boeing ( BA ), Bank of America ( BAC ), Amgen ( AMGN ), Amazon ( AMZN ), Apple ( AAPL ) and AbbVie ( ABBV ) along with many others. Many would say that these are some of the cornerstones of the American economy.

As with most Vanguard funds, this fund also has a negligible expense ratio of 0.04% and it trades exactly at NAV value with no premium or discount. I would say this is a fair price to pay to gain exposure to thousands of corporate funds which would have been very expensive to replicate (especially considering how a lot of individual bonds have minimum investment requirements in thousands of dollars).

Over the years, fund's price had been very stable since bond prices weren't very volatile but last year was an exception to this since global bond markets entered a bear market and even risk-free bonds like US treasuries saw their prices drop significantly. Since there is a negative correlation between bond yields and bond prices, this came as no surprise since the Fed hiking rates would cause bond prices to drop. Short term bond funds like VCSH also saw their price drop since no funds was immune from this action but the drop was pretty mild as compared to other bond types. For example in the last 2 years long term government bond prices ( TLT ) plunged by -43% and the total bond market fund dropped ( BND ) -20% while this fund only dropped -9%. This is partially because most of the bonds in this fund are short-term and one can claim their full price at the maturity regardless of volatility of active bond prices.

The biggest risk for this fund would be more rate hikes from the Fed but it could also be a blessing for long-term holders of the fund as it would mean higher distributions moving forward. If the Fed decided to cut rates for whatever reason, this fund would see some modest price appreciation (about 5-10%) on top of the dividend yield you are collecting but future yield would be much smaller. As an investor in short-term bonds, you are basically at the mercy of the Fed. Then again the same could be said about stock investors and even cash investors regardless of if their cash is sitting in a checking account or in money market funds.

Bond investors spent more than a decade waiting for bond yields to reach acceptable levels as yields barely moved above 0% for the most part. For the last year or so, bond investors are finally seeing some juicy yields but we don't know how long this will last. Many people believe that the Fed will cut rates again at the first sign of trouble and these juicy yields won't last long. If you buy individual bonds you can lock your yield in but this is not possible with basket of short term funds as their yield will fluctuate up and down with market rates so this could also be another risk factor with this fund.

This fund isn't a trading vehicle and it is unlikely to see wild price swings anytime soon. This fund is mostly for parking your excess cash and getting paid while trying to decide what to do with that excess cash. For this very specific purpose, the fund does a good job. It probably wouldn't be suitable for anything else though.

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