Despite Current Risks, Corporate Bonds Offer a Compelling Option

Market uncertainty continues to linger in the back of fixed income investors’ minds. But that can force much-needed recalibration of portfolios as tariffs and rate cuts loom. A compelling option to consider: corporate bonds.

First and foremost, the current environment is conducive to yield opportunities in corporate bonds. Additionally, credit quality is higher due to companies exhibiting stronger fundamentals despite the current risks. The byproduct of higher yields and strong fundamentals means a lower risk premium.

“The ICE BofA US Corporate Index Option-Adjusted Spread gives an aggregate spread level of 0.75,” wrote Darius McDermott in the Financial Times. “This is the lowest level since June 1998. It suggests an environment of low defaults, low borrowing, high economic growth and corporate resilience.”

However, the wild card of tariff contagion still remains, which could mean further volatility in both the equities and bond markets. This is where the income provided by the higher yield of corporate bonds can be beneficial to the latter, according to Bryn Jones, manager of the Rathbone Ethical Bond fund.

“The yields available on many bonds remain much more generous than they’ve been for years,” Jones said. “That huge reset means those yields offer very decent buffers against any further volatility in bond prices, while also offering investors a way to achieve their long-term return objectives through income yields alone.”

Furthermore, with rate cuts looming, fixed income investors whose portfolios comprise mostly Treasuries will want to compensate for falling yields by looking elsewhere. One way to diversify income sources while also reaching for higher yields is corporate bonds.

That said, to counter potential rate cuts, short-term bonds can offer an ideal solution. More specifically, consider the Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH). It seeks to track the performance of a market-weighted corporate bond index with a short-term dollar-weighted average maturity. It employs an indexing investment approach designed to track the performance of the Bloomberg Barclays U.S. 1-5 Year Corporate Bond Index. As of September 3, it has a 30-day SEC yield of 4.31%.

An Intermediate Option

For those looking to step farther out on the yield curve to attain more yield, intermediate bonds can be an option. In particular, consider the Vanguard Interim-Term Corporate Bond ETF (VCIT). The fund offers a balance between mitigating rate risk and reaching for higher yields.

As opposed to assuming greater rate risk with long-term bonds, investors can use VCIT for a median solution to corporate bond exposure. VCIT tracks the Bloomberg U.S. 5-10 Year Corporate Bond Index. That index includes U.S.-dollar-denominated, investment-grade, fixed-rate, taxable securities issued by industrial, utility, and financial companies.

The higher yield of intermediate bonds is reflected in VCIT’s 30-day SEC yield — 4.92% as of September 3.

Both of the aforementioned funds feature a low 0.03% expense ratio, or $3 per every $10,000 invested.

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