VNLA - VNLA: Still A Buy Will Continue To Perform

2023-12-06 07:00:22 ET

Summary

• The Janus Henderson Short Duration Income ETF has performed well in 2023, with a 5.24% total return and minimal volatility.
• Investing in VNLA has outperformed investing in the S&P 500 since January 2022, with lower drawdowns and volatility.
• VNLA is expected to continue delivering high yields and outperforming the market, especially if the Fed cuts rates in mid-2024.
• The portfolio managers have taken an active approach, increasing the fund duration as rates have peaked.
• Most of the fund exposures are below 1% of the collateral, while all issuers are investment grade.

Thesis

Boring works, especially when one does not know what the new year will bring. We are in the midst of another significant market rally, driven by relief over a perceived peak in rates and better-than-expected economic market data. Equities have rallied hard in the past month, mainly driven by high beta names:

A retail investor needs to remind himself/herself that equity as an asset class sits at the bottom of the capital structure, with preferred equity and senior debt having better claims during a bankruptcy proceeding. Equity is thus risky, and should only rally to such a magnitude during a proper bull market.

The Janus Henderson Short Duration Income ETF (VNLA) on the other hand is at the opposite spectrum when it comes to risk. The fund is an expression of a short duration corporate bond vehicle that takes very little duration and credit risk and has performed admirably since we started covering it in February 2023. In our article , we highlighted how the fund's low duration will help it navigate a rising rates environment in 2023, and how its front-ended bond maturities will prevent any significant volatility in the name during the year. We were correct, with the fund posting a 5.24% total return so far in 2023. You might call 5.24% boring, but until recently it beats the equal-weight Invesco S&P 500 (RSP) performance:

A full equity position in RSP would have subjected an investor to an 18% standard deviation, and a negative return on the year until the monster rally in the past two weeks. VNLA on the other hand has a 2.9% standard deviation and an annualized volatility of 1.25%, making it a 'Steady Eddy' type of fund.

You do not have to be a hero

Slow and steady wins the race they say. But yet many investors love the fervor of speculative investing, throwing cash at unprofitable high-beta companies, hoping for a quick turnaround and a high profit. Waiting is the name of the game, and you would be surprised to find out that an investor fully invested in the S&P 500 since January 2022 is still underperforming an investor fully invested in VNLA in the same time frame:

Not only is the VNLA investor outperforming, but that performance was obtained with virtually no drawdowns and de-minimis volatility. VNLA helps you sleep well at night and navigate in a positive territory a very volatile and confusing market. While the SPY is down -1.7% since January 2022 with a -22% drawdown, VNLA is up 5.11% with a -1.5% drawdown.

Expect to see more of the same until we have a confirmed new bull market. We are skeptical though that we have seen all the possible drawdowns in the S&P 500 given a deteriorating LEI (leading economic indicators) picture and an increase in default rates. What we anticipate is a continuation of ample volatility in the SPY, while VNLA will steadily accrue a high annual total return.

VNLA will continue to deliver high yields

VNLA will continue to pay a high dividend yield until the Fed starts cutting rates:

We can clearly see from the above historic dividend yield graph the close correlation in the fund's yield with prevailing Fed Funds rates. VNLA however has a 9-month lag to Fed Funds, driven by its duration. As bonds mature and the vehicle buys new ones, prevailing yields are added to the portfolio and thus begin to move the dividend yield down. The market is currently anticipating a cut in Fed Funds starting mid-2024, thus expect the current dividend yield until Q4 2024. The fund has increased its duration since the last time we covered it, and we are going to speak a bit more about this in the 'Portfolio' section below.

Portfolio

The fund holds over 200 individual names in its portfolio:

We can observe a 36.55% turnover rate here, which indicates a very active portfolio management, so expect the fund to adapt as market conditions change. The fund has taken a smart approach to managing its duration as well, increasing it to 0.8 years since we last wrote about it (it was 0.34 years then).

Given the prevailing view that the peak in rates is behind us, this active approach to increase duration is a very smart move, since it ensures the fund maintains a high dividend for longer, even if the Fed cuts rates. A portfolio manager locks in a yield to maturity when a bond is bought. That yield to maturity lasts for the duration of the bond. When the bond matures a new one is bought on the market, at prevailing yields. Thus, as things currently stand, the fund has a 0.8-years lag to Fed Funds, and thus it will be able to benefit from higher yields until at least the end of 2024 if the Fed cuts mid-2024.

The fund invests solely in high-grade bonds:

While VNLA has a large BBB bucket, we are not that concerned about the probability of default here given the very low duration of the portfolio. In other words, a BBB bond maturing in 9 months is less likely to default versus a BBB bond held for 5 years. The low probability of default for very short tenor bonds is the cornerstone of portfolio construction of short dated bond funds, and what makes them viable cash parking vehicles. The other feature is granularity:

The fund has most of its issuers below 1% of the holdings, with the only outliers being a sovereign bond from New Zealand (rated AA), a AAA CLO fund in JAAA, and two large systemically important financials. The construction is conservative and appropriate.

Conclusion

VNLA is a short dated corporate bond fund that has delivered outstanding results in 2023. We rated this name a Buy in February 2023, and are revisiting it now to see if it should be downgraded. Not a chance. The fund managers have taken the very smart step of starting to increase duration here to 0.8 years as rates have peaked, which is going to translate into the vehicle delivering outsized yields until the end of 2024, even if the Fed cuts in mid-2024.

VNLA exhibits a very low annualized volatility and standard deviation (both found under the 'Risk' tab on the Seeking Alpha platform) and will provide a boring but high dividend yield in the next 12 months as the market continues its volatile swings. VNLA might be boring, but it has outperformed the SPY since January 2022, and in our humble opinion it will continue to do so when all the dust settles in 2024. We reiterate our Buy for this name here and expect continued outperformance from this $2.4 billion fund.

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