Strong Fundamentals Are Underpinning Corporate Bonds

Corporate bonds typically appeal to those seeking higher yield potential relative to safer government debt, but current market uncertainty may keep fixed income investors from making the move. However, strong fundamentals are also underpinning corporate bonds, which only add to their appeal despite ongoing risks.

Additional interest rate cuts by the U.S. Federal Reserve should also provide an additional catalyst for corporate bond demand. Lower rates can allow corporations to refinance their existing loans, thereby lowering debt service costs. In turn, this could translate into stronger balance sheets.

“We see a positive environment for credit into next year,” Vanguard noted in a recent Active Fixed Income Perspectives. “Corporate leverage is stable, margins are strong, and U.S. consumer debt levels remain lower than they were before the 2020 COVID-19 pandemic.”

One notable metric to gauge corporate bond health was cited in the Wall Street Journal. They noted the strong fundamentals via the ratio of EBITDA to interest expense, which is starting to tick in favor for both investment-grade as well as riskier debt. Stronger fundamentals are also translating into tighter credit spreads between investment-grade corporate debt and benchmark 10-year Treasuries.

“Spreads reflect strong company credit measures,” Vanguard added when considering strategies for investment-grade corporate debt. “We remain overweight with a focus on issuer selection.”

4 Options for Corporate Bonds

Risk-averse investors will want to stay within investment-grade debt given the market uncertainty stemming from systematic risks such as geopolitical tensions and tariffs. For a broad option, one ETF to consider is the Vanguard Total Corporate Bond ETF Shares (VTC). The fund tracks the performance of the Bloomberg U.S. Corporate Bond Index, which exposes investors to investment-grade, fixed-rate, and taxable corporate bonds. As of September 30, it carries a 30-day SEC yield of 4.78%, along with a low expense ratio of 0.03%, or $3 for every $10,000 invested.

While VTC provides all-encompassing exposure to corporate debt, investors can also tailor their exposure to the short end, belly, and long end of the yield curve:

1. The Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH) tracks 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.
2. The Vanguard Interim-Term Corporate Bond ETF (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.
3. The Vanguard Long-Term Corporate Bond Index Fund ETF Shares (VCLT) tracks the performance of the Bloomberg U.S. 10+ Year Corporate Bond Index. This index includes U.S.-dollar-denominated, investment-grade, fixed-rate, taxable securities issued by industrial, utility, and financial companies with maturities greater than 10 years.

Like VTC, all three of the aforementioned funds feature a low .03% expense ratio.

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