2023-03-09 15:52:50 ET
Summary
- iShares Aaa – A Rated Corporate Bond ETF is an exchange-traded fund.
- The vehicle holds a very granular portfolio of investment-grade bonds, with an "A" average rating.
- The fund has a 7-year effective duration and a historic performance very similar to the much better-known LQD.
- The main risk factor driving QLTA's performance is represented by rates, with credit spreads secondary.
- The historic relationship between Fed Funds and the 7-year yield is going to drive the next move in QLTA.
Thesis
The iShares Aaa - A Rated Corporate Bond ETF (QLTA) is an exchange-traded fund ("ETF"). The vehicle invests in highly rated investment grade bonds and runs a 7-year effective duration. As per its literature:
The iShares Aaa - A Rated Corporate Bond ETF seeks to track the investment results of an index composed of Aaa to A, or equivalently rated, fixed rate U.S. dollar-denominated bonds issued by U.S. and non-U.S. corporations.
The fund is currently overweight "A" credits, which compose over 83% of its portfolio. From a historic performance standpoint, the QLTA fund is very much aligned with the much better known iShares iBoxx $ Investment Grade Corporate Bond ETF ( LQD ), which aggregates most of the flows in the space.
QLTA represents primarily a play on interest rates, and secondly a play on investment grade credit spreads. If we look at what rates have done in the past year and a half, we get a fairly shocking picture:
Looking at 7-year rates, the duration point that matters for this fund, we can see a tripling in the net yield. That move has resulted in QLTA posting a -11% price performance in the past year, a move which is outside the fund's 3-year standard deviation.
Looking forward to where rates are going, our best bet is to look at the historic relationship between 7-year yields and Fed Funds:
During the past "proper" tightening cycle in 2005-2007, Fed Funds peaked at 5.25% and stayed there for a while. Interesting to note that 7-year yields did not follow, but spent most of the period at a negative difference to Fed Funds, a difference which peaked at -75bps.
We expect a similar playbook this time around - the Fed will raise rates (as per Goldman ) to 5.5% - 5.75% and keep them there for a while. Utilizing the historic precedent, that should translate into a 7-year yield of around 4.75%, which means another 50 bps higher from here.
What does that mean for QLTA? Let us have a look:
Duration Sensitivity (Vanguard)
So, we expect another 50 bps widening in 7-year rates and maybe another 25 to 50 bps from spread widening during the next leg down in this market. This translates into another 1% increase (almost), so maybe another 6% to 7% down for the QLTA fund.
Analytics
- AUM: $0.8 billion.
- Sharpe Ratio: -0.56 (3Y).
- Std. Deviation: 8.6 (3Y).
- Yield: 5% (30-day SEC Yield)
- Premium/Discount to NAV: 0%
- Z-Stat: n/a
- Leverage Ratio: 0%
- Effective Duration: 7 years
- Option Adj Spread: 89 bps.
Holdings
The fund holds a portfolio of investment grade corporate bonds:
The vehicle is overweight financials via its composition:
The QLTA fund has a granular build, with no individual issuer exceeding a 3% holdings threshold:
Furthermore, the QLTA vehicle holds over 2,000 bonds in its portfolio:
Number of Holdings (Fund Fact Sheet)
We do not think the upcoming recession is going to be marked by severe and unexpected financial shocks, therefore, we do not think the probability of default for any name in this portfolio is worth considering. We are of the opinion that in 2023/2024 we are going to witness the weeding out of the excesses witnessed in prior years, especially on the tech and meme stock side.
There are companies out there that have very poor operating earnings (or even negative ones) which are currently burning through their cash balances. Once the money runs out, said businesses will have to close down.
The best way to think about the portfolio of names here is as a well-diversified investment grade collateral pool that would only actually experience defaults in outside scenarios such as the Great Financial Crisis ('08-'09) or Covid, when we had sudden exogenous events that saw investment grade companies default.
Performance
The QLTA fund is down over -11% in the past year, posting a slightly better performance when compared to LQD:
On a 5-year basis, their performance is almost identical:
We can see LQD outperforming during the zero rates environment that characterized 2020 and 2021, but it has re-traced since.
Conclusion
iShares Aaa - A Rated Corporate Bond ETF is a fixed income ETF. The fund aggregates a granular portfolio of investment grade bonds ("A" average rating for over 83% of the portfolio)m, with an overweight tilt towards financials. The fund has an effective duration of 7 years, and has seen its NAV plummet as rates have spiked higher in the past year. QLTA has an almost identical performance to the much better known fund LQD.
The main risk factor affecting QLTA's performance is represented by rates, with credit spreads secondary. With the Fed set to raise rates (as per Goldman ) to 5.5% - 5.75% and keep them there for a while we feel there is still a bit more weakness to come for QLTA. Utilizing the historic precedent from 2007, Fed Funds in the 5.5% range should translate into a 7-year yield of around 4.75%, which means another 50 bps higher from here.
Coupled with slightly wider credit spreads, the above move gives us a price point for iShares Aaa - A Rated Corporate Bond ETF which is around 6% lower than today's level. The QLTA fund is thus a soft Sell.
For further details see:
QLTA: Liquid Investment-Grade Bond Fund, 7-Year Duration