The 50 percent rally in the S&P 500 over the last five months has garnered the attention of investors and has not left much room in the headlines for other asset classes. Sure commodities get some mention from time to time, but even oil and gold have taken a backseat to equities. One asset class that has been shunned off to the Island of Misfits has been corporate fixed income. Corporate bonds have never been the “sexy” investment, but there are times when it is imperative to have exposure to the asset class - I still believe now is a good time to own bonds of all types.
To put the recent moves in perspective, the S&P 500 bottomed in March 2009 and has rallied 50 percent from the low; the Dow Jones Corporate Bond Index has gained 31% from its low in October 2008. There is a clear under performance; however the risk is less for bonds in general. When comparing corporate bonds to treasuries, the spread between the US long bond and an AAA-rated corporate bond was 185 basis points in July, down slightly from May. The spread using the BBB-rated corporate bond, which is still investment-grade, is 353 basis points. The historical average for the AAA-rated is 80 basis points and 178 basis points for the BBB-rated. As you can see the spreads are much higher than normal; but they are also much narrower than they were in the fourth quarter of 2008.
This abnormality caused our firm to begin buying bond ETFs in early 2009 because the opportunity was too good to pass up - the upside was a high dividend yield and the potential for capital appreciation. So far we have been lucky enough to get both. So even though the corporate bond opportunity today is not what it was six months ago, I still believe investors has upside potential with attractive yields that are tough to pass up. Below are a couple bond ETF ideas for investors. I even threw in a muni bond ETF idea I felt was under the radar and offering a great opportunity.
iShares iBoxx Corporate Bond ETF (LQD) - The investment-grade bond ETF invests in a basket of corporate bonds that have a minimum rating of BBB- from Standard & Poor’s. Approximately 75 percent of the holdings are rated A- or better, putting the ETF in a position that the bonds will not likely default in the future. The largest holding in the ETF makes up just over 1 percent of the allocation and there are currently 103 bonds in total. The current yield on the ETF is 5.6 percent and the dividend is paid on a monthly basis to shareholders. The ETF recently hit the highest level in over a year and since March LQD has been steadily moving higher with a consistent dividend payment. This ETF would be a play on more upside in the price of bonds as the yield divergence between corporate and treasuries sends corporate bond yields lower and the corporate bond prices higher. The end result is more upside in price for LQD and locking in at an attractive annual yield.
SPDR Lehman High Yield Bond ETF (JNK) - Investors that intend to cover the entire spectrum of corporate bonds could buy JNK to go along with LQD, as I have done for clients. The makeup of JNK is just the opposite of LQD, the ETF has 98 percent of its holdings below the BBB rating and is composed of high yield (or junk) corporate bonds. With the higher risk comes the potential for more capital appreciation and higher yields. JNK is currently yielding 11 percent
Market Vectors Municipal High Yield ETF (HYD) - HYD was the first ETF to concentrate on high yield municipal bond and caught my attention from day one. The ETF is composed of a basket of high yielding municipal bonds that 75 percent junk status and 25 percent investment grade rated. Considering the ETF is composed of municipal ETFs they are exempt from federal income tax and in many circumstances they are state and local tax free as well. With a distribution yield of 7 percent, the ETF returns an after-tax return of 10.8 percent for taxpayers in the 35 percent tax bracket. Since the ETF began trading in February it is up 9 percent and throwing in the high dividend yield makes the return even higher. I believe HYD is a hidden gem for investors that fall into a high federal tax bracket and are looking for a steady flow of average-risk income with large fluctuations in the underlying security. Keep in mind HYD works best in a taxable account and is not passing along the tax advantages in a tax-deferred account.
In one capacity or another I own shares of all three ETFs for either myself or clients of Penn Financial Group or they have been recommended in The ETF Bulletin newsletter. | 
