Also, received this from a reader recently via email...
"I’d appreciate more articles on “alternative income” ETF’s. I hold a couple of these already, but only have small positions because I don’t feel that I have a full understanding of them. These ETF’s would include LQDH, IGBH, CLOA, CLOI."
For the record, LQDH is the interest rate hedged corporate bond ETF. IGBH is the interest rate hedged long-term corporate bond ETF. CLOA and CLOI are collateralized loan obligation ETFs from BlackRock and VanEck, respectively.
The corporate bond ETFs first. LQDH and IGBH literally hold LQD and IGLB, respectively, but just add interest rate swaps to take the portfolio duration down to zero. To clarify, while those hedges eliminate interest rate risk, they don't eliminate credit risk. These ETFs will still fluctuate up and down with changes in the bond market, but overall they're about 20% less volatile than their counterparts. So there's clearly some risk mitigation advantage by going with the rate hedged options.
That being said, there's also a yield disadvantage. LQDH, for example, yields 4.07% right compared to 5.68% for LQD. So think of these as good examples of the traditional risk/reward tradeoff - less risk, but less yield. As far as whether or not they make good alternative income options, yes I do. It really depends on if you want to make a bet on interest rates or are OK with the volatility associated with them in order to capture that higher yield. Some people want corporate bond exposure to round out their portfolios, but want to take the interest rate risk piece out of the equation. I think that's a perfectly acceptable option, especially since corporate bonds don't always correlate well with Treasuries. LQDH and IGBH aren't big funds and don't really trade a lot, but I still think they can make sense as a longer-term holding.
Admittedly, CLOs aren't my area of expertise, but I'll give it a shot. CLOs are essentially baskets of debt obligations rolled into a single security. These typically aren't traditional bonds. The underlying securities within the CLO are things like leveraged loans issued by private companies, senior loans and things like that. Credit quality can be a concern, but not always.
CLOA focuses strictly on AAA-rated CLOs. CLOI doesn't have that specific restriction, but it's still 83% rated AAA with everything else rated single-A or higher. Both target floating rate securities and come with almost no interest rate risk. Both yield around 6.5%. Both come with roughly 1/4 the volatility of LQDH and IGBH. Because of the yield/risk tradeoff, I do think these make sense as part of a fixed income portfolio. I think the fact that these stick with higly-rated securities is important. CLOs can be dangerous, but both CLOA and CLOI are actively-managed, which should make it able to respond quickly to changes in market conditions.
That is a super helpful reply. Thanks for all the information you included. I have IGBH and LQDH annualized income at 8.0% + based on their most recent distributions. Please let me know if my numbers are off. Thanks again.
What is your take on the whole bond fund vs individual bond with a specific maturity? For example, if you have a 10 year time horizon, can you buy the IEF and sell it in 10 years? Or buy TLT and sell it in 20? Or do you need to buy Bulletshares/iShares iBonds or individual bonds to ensure getting your principal back?
Both of the ETFs you mention are great for constant maturity exposure, but they wouldn't work well in the examples you mention. Those funds are always rolling off notes when they fall outside the target maturity range and adding new ones to replace them. They'll always have maturities within those ranges so they'll never "mature" in the way that a single bond would. Whether you buy them now, in 5 years or in 10 years, it will always have that long-term target maturity range.
The BulletShares/iBonds ETFs, like you mention, are different. They target a very specific maturity date and act like an individual bond, so that would work better. The big difference is you're getting a portfolio of different bonds all maturing at a specific point in time as opposed to obviously just one if you're buying an individual bond.
If you're targeting a specific maturity date to get the principal back, the BulletShares/iBonds ETFs would be the way to go.
I guess the followup would be why own TLT or IEF? Tactical positioning? Almost by definition you’d have to hold them forever as part of some balanced/risk parity portfolio. You can’t use them to match a time horizon. Although personally I think you might end up in a similar place with an individual 10 year vs IEF, etc.
Full disclosure: I own TLT in my personal portfolio.
You're right to say that you can't use them to match time horizon. I own TLT personally because of the duration exposure. My personal belief is that Treasuries are going to make a comeback soon as a safe haven trade. If that happens, TLT gives me the most interest rate exposure and the potential for the biggest gains. In my case, I use TLT for tactical positioning, not income. If I were looking to lock in an interest rate for the long-term for income needs, I'd choose an individual bond or BulletShares ETF. I actually do own a couple of T-bills as a cash alternative in my portfolio simply because I won't need the money for at least a year and I prefer to lock in today's high rates.
I’m holding a lot of SGOV, ICSH, BOXX, SHV and JPST because I want that mostly risk free 5% while it’s available. I think what you’re doing by using TLT to express a view is probably to use it. It just seems like bonds are mostly just talked about in terms of a BND broad exposure.
Investors should definitely not be looking at the bond market in general terms. The current state of the Treasury market is very different than that of the investment-grade corporate bond market is very different than that of the high yield market. I'd be bullish on Treasuries, but no way on high yield IMO.
Also, received this from a reader recently via email...
"I’d appreciate more articles on “alternative income” ETF’s. I hold a couple of these already, but only have small positions because I don’t feel that I have a full understanding of them. These ETF’s would include LQDH, IGBH, CLOA, CLOI."
For the record, LQDH is the interest rate hedged corporate bond ETF. IGBH is the interest rate hedged long-term corporate bond ETF. CLOA and CLOI are collateralized loan obligation ETFs from BlackRock and VanEck, respectively.
The corporate bond ETFs first. LQDH and IGBH literally hold LQD and IGLB, respectively, but just add interest rate swaps to take the portfolio duration down to zero. To clarify, while those hedges eliminate interest rate risk, they don't eliminate credit risk. These ETFs will still fluctuate up and down with changes in the bond market, but overall they're about 20% less volatile than their counterparts. So there's clearly some risk mitigation advantage by going with the rate hedged options.
That being said, there's also a yield disadvantage. LQDH, for example, yields 4.07% right compared to 5.68% for LQD. So think of these as good examples of the traditional risk/reward tradeoff - less risk, but less yield. As far as whether or not they make good alternative income options, yes I do. It really depends on if you want to make a bet on interest rates or are OK with the volatility associated with them in order to capture that higher yield. Some people want corporate bond exposure to round out their portfolios, but want to take the interest rate risk piece out of the equation. I think that's a perfectly acceptable option, especially since corporate bonds don't always correlate well with Treasuries. LQDH and IGBH aren't big funds and don't really trade a lot, but I still think they can make sense as a longer-term holding.
Admittedly, CLOs aren't my area of expertise, but I'll give it a shot. CLOs are essentially baskets of debt obligations rolled into a single security. These typically aren't traditional bonds. The underlying securities within the CLO are things like leveraged loans issued by private companies, senior loans and things like that. Credit quality can be a concern, but not always.
CLOA focuses strictly on AAA-rated CLOs. CLOI doesn't have that specific restriction, but it's still 83% rated AAA with everything else rated single-A or higher. Both target floating rate securities and come with almost no interest rate risk. Both yield around 6.5%. Both come with roughly 1/4 the volatility of LQDH and IGBH. Because of the yield/risk tradeoff, I do think these make sense as part of a fixed income portfolio. I think the fact that these stick with higly-rated securities is important. CLOs can be dangerous, but both CLOA and CLOI are actively-managed, which should make it able to respond quickly to changes in market conditions.
That is a super helpful reply. Thanks for all the information you included. I have IGBH and LQDH annualized income at 8.0% + based on their most recent distributions. Please let me know if my numbers are off. Thanks again.
I used 30-day SEC yields. Trailing 12-month dividend yields may be higher or lower. I don't have the numbers in front of me. They both may be right.
What is your take on the whole bond fund vs individual bond with a specific maturity? For example, if you have a 10 year time horizon, can you buy the IEF and sell it in 10 years? Or buy TLT and sell it in 20? Or do you need to buy Bulletshares/iShares iBonds or individual bonds to ensure getting your principal back?
Both of the ETFs you mention are great for constant maturity exposure, but they wouldn't work well in the examples you mention. Those funds are always rolling off notes when they fall outside the target maturity range and adding new ones to replace them. They'll always have maturities within those ranges so they'll never "mature" in the way that a single bond would. Whether you buy them now, in 5 years or in 10 years, it will always have that long-term target maturity range.
The BulletShares/iBonds ETFs, like you mention, are different. They target a very specific maturity date and act like an individual bond, so that would work better. The big difference is you're getting a portfolio of different bonds all maturing at a specific point in time as opposed to obviously just one if you're buying an individual bond.
If you're targeting a specific maturity date to get the principal back, the BulletShares/iBonds ETFs would be the way to go.
I guess the followup would be why own TLT or IEF? Tactical positioning? Almost by definition you’d have to hold them forever as part of some balanced/risk parity portfolio. You can’t use them to match a time horizon. Although personally I think you might end up in a similar place with an individual 10 year vs IEF, etc.
Full disclosure: I own TLT in my personal portfolio.
You're right to say that you can't use them to match time horizon. I own TLT personally because of the duration exposure. My personal belief is that Treasuries are going to make a comeback soon as a safe haven trade. If that happens, TLT gives me the most interest rate exposure and the potential for the biggest gains. In my case, I use TLT for tactical positioning, not income. If I were looking to lock in an interest rate for the long-term for income needs, I'd choose an individual bond or BulletShares ETF. I actually do own a couple of T-bills as a cash alternative in my portfolio simply because I won't need the money for at least a year and I prefer to lock in today's high rates.
So I guess I use Treasuries for both purposes.
I’m holding a lot of SGOV, ICSH, BOXX, SHV and JPST because I want that mostly risk free 5% while it’s available. I think what you’re doing by using TLT to express a view is probably to use it. It just seems like bonds are mostly just talked about in terms of a BND broad exposure.
Investors should definitely not be looking at the bond market in general terms. The current state of the Treasury market is very different than that of the investment-grade corporate bond market is very different than that of the high yield market. I'd be bullish on Treasuries, but no way on high yield IMO.
Really appreciate your insights.
Appreciate the questions! It's a good thought experiment.
*probably the best way to use TLT