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Investor Guide To The iShares Investment Grade Corporate Bond ETF (LQD)

November 17th, 2012

Stephen Simpson: Fixed income securities have long been a major part of investor portfolios; corporate bonds in particular often hold a key role. In many cases investment-grade corporate bonds can have a “win-win” impact on portfolios, reducing overall volatility while also delivering income. Unfortunately, bonds have some attributes that make them less than ideal for many individual investors; because investors cannot buy or sell partial “shares” of a bond, it can be difficult for investors to buy and hold a truly diversified portfolio [see also How To Pick The Right ETF Every Time].

This is where the iShares Investment Grade Corporate Bond ETF (NYSEARCA:LQD) comes into the picture. LQD is one of the most popular options for investors looking to gain exposure to the corporate bond market, and it’s well worth a closer look.

In A Nutshell

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This ETF seeks to replicate the returns of the iBoxx U.S. Dollar Liquid Investment Grade Index, an index created by Markit to reflect the broader market for corporate bonds (trading in U.S. dollars). The index explicitly excludes convertible bonds, preferred equities, floating rate notes, zero-coupon bonds and bonds with any other sort of equity kicker attached. Other requirements include at least three years to maturity, an investment-grade rating, and at least $2 billion in bond issuance [see Bond ETFs For Every Objective].

The iShares Investment Grade Corporate Bond ETF (LQD) was launched in July of 2002.

What Makes LQD Unique

If for nothing else, LQD is unique in its size – forget being the largest corporate bond ETF on the market, it’s the largest bond ETF period. LQD holds over 1,000 bonds in its portfolio, with a wide range of sectors and credit ratings represented. It is not necessarily unique in terms of its portfolio size, but it is on the larger/more diverse end of the spectrum [for more bond ETF analysis subscribe to our free newsletter].

How It Fits

LQD has many characteristics that argue for it being a core holding in many investors’ portfolios. Given its size and liquidity, these shares could also be a reasonable option for investors who wish to trade more actively and/or use more sophisticated strategies including options or futures.

LQD offers a relatively low expense ratio and a diverse collection of bonds, making it a very good option for investors who wish to hold fixed income assets and/or build a diverse portfolio that includes both equities and fixed income. What’s more, corporate bonds offer relatively low correlation to equities, which makes this an appealing holding to reduce overall portfolio volatility.

Last and not least, LQD is a good option for investors looking to generate current income from their portfolio. Investors should note, though, that distributions from this ETF do not enjoy the same tax advantages as federal, state, or municipal bonds.

What It’ll Cost You

LQD charges a management fee of 0.15%; this price tag is on the low end of the overall bond ETF range of 0.12% to 0.55% (and average of 0.23%), and is likewise on the low end of the 0.12% to 0.30% range for investment-grade corporate bond ETFs. All in all, both within its peer group of bond ETFs and the broader group of ETFs, LQD counts as a very cheap holding in terms of expense ratios. It is also worth noting that the fund has not made any short or long-term capital gains distributions in recent history [see also The Top 10 Cheapest And Most Expensive ETFs].

Investors can buy and sell this fund commission-free through Fidelity and TD Ameritrade.

Under The Hood

LQD holds a deep and balanced portfolio of more than 1,000 corporate bonds. Its top ten holdings account for less than 5% of total fund assets, resulting in a truly well-rounded portfolio.

The fund’s holdings are also rather diverse with respect to sector exposure and credit risk. About one-third of the fund’s holdings are in the financial sector, which isn’t surprising given that financial firms are the largest issuers in the corporate bond market. Financials, consumer services, and oil/gas companies comprise more than half of the fund’s holdings, and the fund’s sub-5% exposure to technology, industrials and utilities may surprise some would-be investors [see Monthly Dividend ETFdb Portfolio ETFdb Pro Members Only].

Within credit risk, all bonds must carry an investment-grade rating, but about 50% of the fund’s holding cluster around the Moody’s A3 – Baa2 range. Less than 2% of the holdings are rated AAA/Aaa, with about one-quarter rated below BBB+/Baa1.

Investors may want to note that the index/fund uses a weighted approach that gives the largest weights to the biggest issues of debt. Practically speaking, this doesn’t have a huge impact. The largest holdings, bonds from Walmart (WMT) and Wells Fargo (WFC), are just 0.45% of assets apiece, but it may nevertheless be an issue for some investors.

Yield, Volatility and Performance

LQD pays out a dividend distribution on a monthly basis. As a well-diversified corporate bond fund, the volatility of LQD falls basically as investors should expect – below broad stock market indices, but above U.S. Treasury benchmark [see our High Yield ETFdb Portfolio ETFdb Pro Members Only].

LQD has been a solid performer in the bond space. The fund’s total returns (NAV) since 2008 have been as follows: 2008 (-0.3%), 2009 (12.1%), 2010 (9.1%), 2011 (8.9%). During that same period of time, the stock market (as represented by the SPY ETF) has returned: 2008 (-37%), 2009 (26.4%), 2010 (14.9%), 2011 (2.1%).

Other Options

While LQD is an impressive fund with many appealing characteristics, it is not the only corporate bond ETF that investors can select. The following ETFs offer generally similar exposures as LQD, but with some particularly distinguishing characteristics.

  • SPDR Barclays Capital Short-Term Corporate Bond ETF (SCPB): This is the cheapest corporate debt ETF in terms of expense ratio (just 0.12%), but this fund holds fewer positions (between 600 and 700) and the effective duration is much, much shorter (1.9 for SCPB versus 7.8 for LQD).
  • SPDR Barclays Capital Issuer Scored Corporate Bond ETF (CBND): This fund does not use the market-weighted approach of LQD, instead using fundamental factors like interest coverage and return on assets to construct the portfolio.
  • PowerShares International Corporate Bond ETF (PICB): This ETF takes an entirely different approach, basing its holdings on the S&P International Corporate Bond Index, which includes bonds issued in ten different non-U.S. currencies. Accordingly, this fund is appropriate for only those wishing to have non-U.S. corporate bond exposure, and both the net assets and volume are small for bond ETFs.
  • iShares Floating Rate Note ETF (FLOT): This ETF addresses the interest rate risk in a fund like LQD by holding dollar-denominated, investment-grade floating rate notes. Like PICB, this fund has a relatively small asset base and volume for a bond ETF.

Written By Stephen Simpson From ETF Database  Disclosure: No positions at time of writing.

ETF Database is committed to giving our audience, consisting of both active traders and buy-and-hold investors, information that, to ourknowledge, is truthful and non-biased. [For more ETF insights, sign up for our free ETF newsletter or try a free seven day trial of ETFdb ProETFdb Pro Members Only.]

 


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