Beware Possible Rip Current Under ‘LQD’

September 12, 2016

The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) was the most popular fixed-income ETF in August, raking in $1.3 billion in fresh net assets last month. The ongoing massive inflows into this ETF are beginning to worry some market experts.

Consider that the August inflows brought LQD’s net asset gains for 2016 to an impressive $6.8 billion—the fourth-largest year-to-date net creations among all ETFs and a 20% jump in the fund’s AUM. LQD today has $33 billion in total assets.

The fund’s popularity with investors this year, many say, is yet another indication of investors’ desperate search for income. In a world of compressed yields around the globe, and low-returning stocks, corporate credits are a good place to be if you are looking for yield.

LQD is currently shelling out 30-day yields of 2.85%, and a distribution yield—the 12-month yield an investor would get if the latest distribution and share price stayed the same—of 3.05%. That’s for a portfolio that has effective duration of about 8.5 years. (Effective duration is a measure of the fund’s sensitivity to interest rate changes.)

For perspective, 10-year Treasurys are yielding about 1.67%. A Treasury fund such as the iShares 7-10 Year Treasury Bond ETF (IEF), which has effective duration of about eight years, is serving up 30-day yields of 1.35%—less than half that of LQD.

And performance has been good too. The chart below shows LQD’s year-to-date gains relative to IEF, as well as the SPDR S&P 500 (SPY), and an aggregate bond strategy, the iShares Core U.S. Aggregate Bond ETF (AGG). LQD is the best-performing of the bunch, and by a good margin: 

 

Chart courtesy of StockCharts.com

 

But there are signs of trouble lurking, Bob Smith, president and chief investment officer of Sage Advisory Services in Austin, Texas, said.

“LQD is not bad in and of itself, but it’s like the SPDR Gold Trust (GLD) to the average small investors,” he said. “They race in when gold is hot, and they race out when it’s not. The problem is that the bigger it becomes, the more difficult it is to sustain balance in that market when the flows go the other way, if they do.”

 

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