Can You Count on Bond Funds for Stability?

A reader left a comment on my blog asking about the iShares iBOXX $ Investment Grade Corporate Bond Fund(LQD Quote). He was using it as a proxy for a stable value fund, though it was bouncing all around. The reader wanted my opinion on its prospects for recovery.

LQD invests in corporate bonds whose average rating currently is S&P A+, the weighted average maturity is 11.2 years, the weighted average duration is 6.3 years, the yield is just over 6% and the expense ratio is 0.15%.

The fund got crushed because it is roughly 40% in issues of financial companies, many of which were front and center in the financial crisis. The position page on the iShares Web site shows two Lehman Brothers issues worth close to zero, another Lehman issue trading at 16 cents on the dollar, an AIG issue trading at 52 cents and 30 other issues (out of 100) trading below 90 cents.

Notice that these are still in the fund. Currently, there are a couple of issues each from Goldman Sachs, Morgan Stanley and Wachovia. This crisis has been a great reminder that any company can fail. While predicting who's next is not a game I'm any good at, if there is a next, which seems reasonable, and it is one or more of those three, the fund would take another hit.

As for LQD's longer-term prospects, it comes down to one thing: Is the bond market permanently broken? While figuring out how long it will take to be fixed might be difficult, the bond market will return to normal even if it takes longer than we think or would like.