Top 10 Corporate Bond ETFs: Pros vs. Cons

NEW YORK ( TheStreet) -- In an era of low interest rates, and perhaps a good deal of distrust of equity markets, investing for income has become quite a challenge. There are many ETF sectors in which yield is a prime consideration. With fixed income and bonds, the menu consists of the following: corporate, high yield, municipal, emerging market, government, international government, inflation-protected, mortgage-backed and preferred stock.

Many institutional investors (insurance companies and large pension plans) must have an allocation to bonds. Many asset allocation plans include bonds for individual investors. Clearly, savers and seniors especially gravitate to them for safety and income.

We'll be evaluating most of these issues and sectors beginning with corporate bonds. While we haven't included all that are available, we've sorted the top 10 below by AUM, or assets under management. It doesn't mean we favor one over another and perhaps newer issues might even have better features, but haven't been seasoned enough to garner significant assets yet.

Corporate bond yields range from 2%-4% overall. Investors should remember most corporate bond issues have call dates, which would mandate early redemption at the option of the issuer. These can limit capital appreciation.

Corporate bond supply is quite plentiful, given low yields. This has made it compelling for companies to take advantage low-cost funding for many purposes, including stock buy-backs and rebuilding balance sheets.

Typically, most bond issues and sectors aren't highly correlated to stocks. This was especially true during the previous bear market. However, recently, given unusual Fed policies combining ZIRP (zero interest rate policies) with QE (quantitative easing), these non-correlations have become less apparent. This may prove temporary.

As a former bond principal, I'm really not in favor of bonds now. Yields are skimpy and risks from budding inflation is high with longer maturities. With shorter maturities, you do little better than yields from the bank after headline inflation. More on that later.


10. iShares iBoxx Investment Grade Bond ETF ( LQD) tracks the iBoxx Liquid Investment Grade Index comprising over 600 bond issues. AUM is $13 billion and daily trading volume averages just under 1 million shares. More than 70% of constituent holdings have maturities between 3 and 10 years. This would be considered moderate and offers less duration risk.

The current yield for LQD is 4.74%. The year-to-date market return through May 2011 has been less than 3%.

LQD Top Ten Holdings

  1. AT&T 5.5%: 0.95%
  2. Wells Fargo & Co New York 5.625%: 0.91%
  3. JP Morgan Chase 6.3%: 0.85%
  4. American International Group 5.85%: 0.82%
  5. JP Morgan Chase 4.65%: 0.82%
  6. Citigroup 8.5%: 0.80%
  7. Wal-Mart Stores 6.5%: 0.79%
  8. General Electric Capital 5.625%: 0.78%
  9. Credit Suisse New York 5.3%: 0.75%
  10. Verizon Communications 8.75%: 0.75%

9. iShares 1-3 Year Credit Bond ETF ( CSJ) tracks the Barclays Capital U.S. 1-3 year Credit Bond Index, which includes corporate and sovereign debt and non-U.S. agency bonds. The bonds held are shorter-term in duration, virtually eliminating duration risk. Bonds within the holdings are all investment grade. AUM is more than $8 billion and trading volume averages more than 475,000 shares daily.

YTD market return through May 2011 has been 1.18%, while the yield is roughly 2.29%.

CSJ Top Ten Holdings (Interest, Weighting)

  1. Kreditanstalt Fur Wiederaufbau 1.875%: 0.90%
  2. Citigroup 6.5%: 0.90%
  3. European Investment Bank 1.625%: 0.87%
  4. General Electric 5%: 0.81%
  5. International Bank For Reconstruction 1.75%: 0.80%
  6. Kreditanstalt Fur Wiederaufbau 1.375%: 0.80%
  7. Kreditanstalt Fur Wiederaufbau 3.5%: 0.72%
  8. European Investment Bank 1.25%: 0.71%
  9. CS First Boston New York 5%: 0.62%
  10. Kreditanstalt Fur Wiederaufbau 1.375%: 0.62%

8. iShares Barclays Intermediate Bond ETF ( CIU) follows the Barclays Intermediate Credit Bond Fund Profile, which consists of investment grade bonds with maturities of greater than one year but less than 10 years. CIU has AUM of roughly $3.4 billion with average daily trading volume of just less than 200,000 shares.

CIU has a yield of approximately 4% and has returned 2.55% through May 2011.

CIU Top Ten Holdings

  1. European Investment Bank 4.625%: 0.67%
  2. International Bank For Reconstruction 2.125%: 0.47%
  3. Kreditanstalt Fur Wiederaufbau 4.375%: 0.47%
  4. Cisco Systems 5.5%: 0.46%
  5. Italy Republic 4.5%: 0.45%
  6. European Investment Bank 2.75%: 0.38%
  7. General Electric Capital Corp 2.8%: 0.38%
  8. Citigroup 5.5%: 0.35%
  9. AT&T 2.5%: 0.33%
  10. International Bank For Reconstruction 2.375%: 0.33%

7. Vanguard Short-term Corporate Bond ETF ( VCSH) also tracks the Barclays Capital U.S. 1-5 Year Corporate Index, which includes U.S. dollar-denominated, investment-grade securities. Vanguard, in general, would like to compete with similar offerings based on lower fees. And, if you're an investor with a long-term investment horizon and with interest rates this low, fees could matter. VCSH's expense ratio of .15%, versus .20% for other similar products, is possibly more appealing. AUM equals $1.5 billion and average daily trading volume is roughly 160,000 shares.

Through May 2011 YTD return has been 1.79% with a yield of 2.33%.

VCSH Top Ten Holdings

  1. General Electric Capital Corp 5.45%: 1.77%
  2. Wells Fargo Corp 3.75%: 1.11%
  3. Morgan Stanley 5.3%: 0.91%
  4. Goldman Sachs Group 3.625%: 0.90%
  5. CS First Boston New York 5%: 0.89%
  6. Citigroup 5.5%: 0.77%
  7. Goldman Sachs Group 5.25%: 0.73%
  8. Bank Of America Corp 6.25%: 0.70%
  9. AT&T 4.95%: 0.68%
  10. JP Morgan Chase 4.75%: 0.66%

The 6. iShares Barclays Credit Bond ETF ( CFT) follows the Barclays Credit Bond Index, which includes dollar-denominated corporate and agency debt and has maturities greater than one year. In the top 10 holdings, you'll note a mix between dollar-denominated overseas issues and even a municipal bond issue. AUM is $862 million and average daily trading volume is roughly 54,000 shares. Nearly 75% of current maturities are within 10-years. The annual expense ratio is .20%.

Through May 2011 CFT has returned 2.98% with a yield of 4.42%.

CFT Top Ten Holdings

  1. European Investment Bank 5.125%: 0.52%
  2. Citigroup 8.5%: 0.35%
  3. General Electric Capital Corp 5.625%: 0.33%
  4. Morgan Stanley 4.75%: 0.31%
  5. Wyeth 5.5%: 0.31%
  6. Morgan Stanley 6%: 0.30%
  7. Bank of America Funding 4.5%: 0.30%
  8. European Investment Bank 2.75%: 0.28%
  9. California State GO Bonds 7.55%: 0.28%
  10. United Mexican States 5.95%: 0.28%

5. Vanguard Intermediate Term-Corporate Bond ETF ( VCIT) tracks the Barclays Capital U.S. 5-10 Year Corporate Bond Index. AUM equals $518 million, while daily trading volume averages roughly 65,000 shares. Typical of Vanguard's fee structure is a .15% expense ratio.

Through May 2011, VCIT has returned 3.45%, with a yield of 4.17%.

VCIT Top Ten Holdings

  1. Morgan Stanley 5.45%: 1.60%
  2. Bank America Funding 5.65%: 1.47%
  3. US Treasury Note 2.625%: 1.26%
  4. Bear Stearns Cos 6.4%: 1.13%
  5. Wells Fargo & Co New 5.625%: 1.01%
  6. Bank America Charlotte 5.3%: 0.96%
  7. General Electric Capital Corp 5.625%: 0.94%
  8. Citigroup 6.125%: 0.87%
  9. American Express 7%: 0.84%
  10. AT&T 5.5%: 0.82%

4. SPDR Barclays Capital Short-Term Bond ETF ( SCPB) follows the Barclays Capital U.S. 1-3 Year Corporate Bond Index. AUM equals $360 million, while average daily trading volume is around 94,000 shares. For investors not wishing to pay higher fees, SCPB has a low expense ratio of only .12%, which doesn't eat away too much of already-low yields.

Through May 2011, SCPB has returned 1.21% and has a current yield of 1.87%.

SCPB Top Ten Holdings

  1. Wells Fargo & Co New 5.25%: 1.55%
  2. General Electric Capital Corp 4.8%: 1.15%
  3. General Electric Capital Corp 6%: 1.03%
  4. JP Morgan Chase 5.375%: 1.01%
  5. Verizon Wireless Capital 7.375%: 0.99%
  6. CS First Boston New York Sr 5%: 0.93%
  7. Goldman Sachs Group 5.25%: 0.89%
  8. Morgan Stanley 2.875%: 0.88%
  9. Citigroup 6.5%: 0.86%
  10. Goldman Sachs Group 5.45%: 0.83%

3. SPDR Barclays Capital Intermediate-Term Bond ETF ( ITR) tracks the Barclays Capital Intermediate U.S. Corporate Index. The index includes dollar-denominated debt from U.S. and non-U.S. industrial utility and financial institutions with less than 10 year durations. AUM equals $183 million and the average daily trading volume is roughly 37,000 shares. The expense ratio is .15%.

Through May 2011, ITR has returned 2.7% and currently yields 3.5%

ITR Top Ten Holdings

  1. General Electric Cap Corp 4.8%: 1.43%
  2. Goldman Sachs Group 5.95%: 1.15%
  3. JP Morgan Chase 4.65%: 1.04%
  4. Morgan Stanley 3.45%: 0.96%
  5. American Express 7.25%: 0.91%
  6. Verizon Comms 5.25%: 0.90%
  7. Wachovia Corp Global 5.5%: 0.88%
  8. Merrill Lynch Co Inc 6.875%: 0.84%
  9. Morgan Stanley 4.75%: 0.83%
  10. Citigroup 5.5%: 0.83%

2. Vanguard Long-Term Corporate Bond ETF ( VCLT) tracks the Barclays Capital U.S. Long Corporate Index, which is investment grade, dollar-denominated, with maturities greater than 10 years. AUM equal $104 million and average daily trading volume is roughly 13,000 shares. Typical for Vanguard, the expense ratio is a low .15%.

Through May 2011, VCLT has returned 2.95% and has a current yield of 5.34%.

VCLT Top Ten Holdings

  1. General Electric Capital Corp 5.875%: 1.74%
  2. News America 6.15%: 1.39%
  3. Time Warner Companies 6.625%: 1.34%
  4. Comcast Corp New 6.95%: 1.29%
  5. Verizon Communications 6.9%: 1.18%
  6. SBC Communications 6.15%: 1.16%
  7. Kraft Foods 6.5%: 1.08%
  8. HSBC Holdings 6.8%: 1.04%
  9. UnitedHealth Group 6.875%: 0.99%
  10. Goldman Sachs Group 6.75%: 0.99%

1. PIMCO Investment Grade Corporate Bond ETF ( CORP) tracks the Bank of America/Merrill Lynch U.S. Corporate Index with dollar-denominated investment grade issues with maturities greater than one year. CORP is a relatively new issue (September 2010) and has AUM of $83 million, with average daily trading volume of around 6,000 shares. The expense ratio is .20%. A feature is, CORP rebalances its holdings monthly, which should be a tax consideration for some investors.

Holdings for CORP are unavailable at this time.

Through May 2011, it has returned 1.72% and, per PIMCO's Web site, the current 30-day yield is 3.57%.

The choices for investors looking for safer returns with higher yields away from Treasury bonds generally will turn to investment grade corporate bonds first.

The list is long and sometimes quite repetitive, as components vary little one to another. The real choice here is maturity selection or which duration risk you are willing to assume? The longer out the curve you go, the greater the return and risk to principal.

Again, I'm really not in favor of bonds now. It may be that I suffer from the "the more you know about something, the less you like it" syndrome. Nevertheless, as I wrote in the beginning, yields are skimpy and risks from budding inflation is high with longer maturities. With shorter maturities, you do little better than yields from the bank after headline inflation. So, given the environment, with many uncertainties, "cash" from money market funds and/or T-Bills is just fine for now.

Remember, many institutions (insurance companies, pension plans and many asset allocation models) call for large bond allocations. Some insurance companies may only own bonds, given their actuarial table requirements. If you're an individual investor you're not under the same pressures, no matter what you hear in the media.

Further previous non-correlations of bonds to stocks, for example, have been whittled away, given current monetary policies of the Fed. This only adds to risks already mentioned.

If you must buy them, our bias generally is to more liquid issues unless we utilize them in Lazy portfolio approaches. Just always remember ETF sponsors must issue and many times their interests aren't aligned with yours. They have a business interest and wish to have a competitive presence in any popular sector.

For further information about portfolio structures using retail or other ETFs see www.etfdigest.com.

You may address any feedback to: feedback@etfdigest.com

(Source for holding data is from ETF Database.)

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Dave Fry is founder and publisher of ETF Digest, Dave's Daily blog and the best-selling book author of Create Your Own ETF Hedge Fund, A DIY Strategy for Private Wealth Management, published by Wiley Finance in 2008. A detailed bio is here: Dave Fry.

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