Understanding Fed Effects on Corporate Bond ETFs

Fixed income investors know that bond prices and yields move inverse of one another. That means when yields decline, prices rise. And that’s perhaps the biggest reason the Fed moves are so widely monitored.

The price/yield scenario holds true across the bond universe. That means Fed action is impactful for ETFs such as the Neuberger Berman Flexible Credit Income ETF (NBFC). The fund lives up to its “flexible” billing. That’s because the actively managed fund features both investment-grade and high-yield corporate debt on its roster.  Those two corners of the bond market are front-and-center amid hopes the Fed has only just begun paring rates.

Against the backdrop of Fed easing, NBFC’s status as an active ETF is pertinent for myriad reasons. That includes a concept some newer bond investors overlook: options-adjusted spreads (OAS).

“Looking at the OAS spreads between the Bloomberg U.S. Corporate Investment Grade (IG) Index and U.S. Corporate High Yield Very Liquid (HY) Index reveals different perspectives on risk and volatility within each of their respective credit markets,” according to CME Group research.

NBFC Built for This Environment

As advisors and investors know, junk bonds are sensitive to changes in interest rates. This year’s upside by those bonds, including those residing in NBFC, is likely the result of expectations of Fed easing. That sensitivity also underscores the benefits of NBFC being actively managed.

Junk debt’s “OAS is prone to relatively large and rapid increases, a direct reflection of the heightened risk and volatility in the high yield bond market. This sensitivity makes it a powerful barometer for capturing market-wide risk appetite,” added CME.

One way of looking at that is that volatility on high-yield corporate debt is typically higher than what’s found in higher quality corporates. Investors are compensated for that risk in the form of higher yields. But they can a step further by embracing NBFC as volatility mitigation strategy.

Looked at through the prism of OAS, investors should expect significantly OAS behavior between investment-grade and high-yield corporates, particularly when the Fed is adjusting borrowing costs. However, an ETF like NBFC can ease those concerns because the fund’s management team is doing the heavy lifting for end users.

“The clear differences in the OAS behavior between the two indexes provide a compelling rationale for trading the spread between them. The HY less IG OAS spread is critical to credit traders who anticipate either a widening or tightening of the gap in credit premiums between the two markets,” concluded CME.

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