We have had some clients interested in making use of corporate debt allocations in an effort to emulate “sophisticated” large corporate treasury departments. These departments tend to buy investment grade bonds and hold them to maturity, often opting to buy shorter dated bonds. Is there an easy way to do this without hiring a treasury team and trading hundreds or thousands of individual corporate bonds? And more importantly, is it advantageous to deploy such a strategy?
Target Date ETFs
A couple of asset managers have launched ETF bond families that have target year ETFs which hold bonds expiring in a particular year. This is yet another innovation in the ETF space where we see creative vehicles for holding particular strategies or market exposures. Many option based ETF strategies are similar in nature to these bond ETFs by the fact that there is an expiration date for the ETF which limits the risk and defines the return profile of the particular fund.
To give you a sense of the data, we plot some of the historical returns. First, the returns of a family of expiring investment grade bond ETFs prior to splicing the returns:
Source: Bloomberg
Splicing the returns and cumulating the returns:
Source: Bloomberg
First a word of Caution
Based on the result of our research, two things stand out:
- The returns have gaps at the end of the year as each ETF in the series matures and terminates. These gaps combined with low relative returns result in negative excess returns versus a 1-3 month Treasury index return. Accordingly, it seems holders are not being paid for the credit risk.
- 2020 saw an incredible 6% drawdown for IG bonds when liquidity was at a premium at the onset of the pandemic. If you are a Treasury department inside of a corporate treasury, perhaps you don’t necessarily have this mark to market risk. Conversely, if you really needed cash at that moment, the liquidity premium is real.
Some optimization
If we move the allocation by 6 months (taking slightly more duration risk) and avoid the wind down of the fund, the data changes to:
Source: Bloomberg
Source: Bloomberg
So by avoiding the ETF’s wind down, removing the uninvested periods and taking slightly more risk you end up with positive excess returns but you still would not avoid a liquidity crunch like we saw in 2020.
Putting things in perspective
Let’s compare the result from our optimization above to a 1 to 3 year credit index:
Source: Bloomberg
As we can see above the two wealth paths are certainly different but the ending point is almost identical for the time period we examined. The spliced IG ETF series unbelievably has slightly higher vol, probably caused by the 2020 episode. Apart from 2020, the optimized Target date ETF strategy provides a decent way to take targeted credit exposure using these new ETF tools.
Now, most importantly: does this strategy outperform some of Treasure’s existing allocations? We are not able to discuss in detail in this blog due to regulatory restrictions around performance advertising but you can reach out to support@treasure.tech to request our analysis.
Conclusion
We reviewed here a potential allocation to Corporate bonds via an allocation to Fixed Income ETFs. While their risk characteristics might be appealing, the result is poor compared to some other available alternatives. This also begs the question: should corporate treasurer’s review their investment strategy?
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