A reader left a comment on my blog asking about the
iShares iBOXX $ Investment Grade Corporate Bond Fund
. 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
. 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.
LQD, like most other ETFs, is a proxy for something, in this case, corporate bonds. That market is obviously distorted, and so the fund has paid the price, down 6.3% just on Sept. 16.
Before the crisis devolved into a meltdown, LQD behaved as you would expect a bond fund to behave. Most of the time it did nothing (not a bad result for a bond fund), with only the occasional disruption. I would expect that when the bond market returns to normal, so, too, will LQD.
The reader's question has another dimension that should be addressed, which is the way he was using the product, as a stable value fund. There is no way to know if the reader did not understand the product or was reaching for yield, but hopefully you can learn from his experience.
In looking for a stable value proxy, as opposed to paying a mutual fund to manage one for you, it makes much more sense to go very short term and take as little credit risk as possible. The easiest place to look would be a short-term Treasury ETF like
SPDR Lehman 1-3 Month T-Bill ETF
or the actual T-bills. Don't let the Lehman name throw you; SPDR pays a licensing fee to Lehman (or what's left of it) for use of the index.
The advantage of going this route is there is no realistic need to worry about what the next part of the fixed-income market to seize up will be or whether the money-market fund will break the buck.
The downside is the yield will be close to zero for the time being, and if you go with the ETF, you will have to pay a commission. Before you dismiss such a low yield, the fixed-income market is not working the way it normally does.
Anytime the fixed-income market is distorted, it can trigger price movement that may not be easily foreseen. Under that circumstance, it makes sense to go as conservative as possible and not own something like LQD as a stable value holding.
The best thing for someone with a low tolerance for risk or volatility is to accept the low yield and be patient. With the flurry of failures lately, the old quote about return of capital versus return on capital stands up and should be the priority for money you cannot lose or see decline.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
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