What are corporate bond ETFs?

What are corporate bonds?

Corporate bonds are exactly what they sound like, a bond issued by a corporation. Bonds are essentially an IOU that a corporation issues when looking to raise money. These funds could be used for an expansionary project or to fund an acquisition.

Usually, a company promises to pay coupon payments and eventually pay back the principal (the amount borrowed) to the bond investor. 

The distinction between corporate bonds and US treasures is that corporate bonds entail default risk. The US government theoretically cannot default since it has the ability to tax its citizens or print money in order to meet its debt obligations. However, corporations can, and often do, default on their debt. This leads to what is called ‘credit ratings,’ which is essentially a measure of the probability of default for certain companies. These credit ratings are different by agency, but broadly can go from investment-grade (less risky) to high-yield (more risky).

Some companies that are highly profitable and carry very little debt (think Apple and Meta) will receive very high credit ratings. In contrast, companies with a lot of debt and little pricing power (think commodity producers) will likely have lower credit ratings.

While this additional risk may be considered a bad thing, investors can demand higher returns to compensate for this additional risk. Therefore, corporate bond investments almost always have higher returns than government bonds, assuming of course that they do not default.

Why invest in corporate bond ETFs?

Corporate bond ETFs are an easy way for an individual investor to gain exposure to the asset class. They offer numerous benefits, including:

1. Less initial capital required: to purchase an individual bond from a company would take a lot of capital, however with ETFs investors can pool their capital together
2. Broader diversification: since bond ETFs hold many bonds, investors are not as exposed to individual companies defaulting – thereby isolating the corporate bond return premium
3. Convenience, transparency and cost: self-explanatory, purchasing a corporate bond ETF allows an investor to enter/exit positions at will, have full transparency over what they are invested in, and also invest in corporate bonds at a lower cost than purchasing the bond outright themselves 

How to gain exposure to corporate bonds with ETFs

The following ETFs offer exposure to corporate bonds. Alternatively, ETF Central’s fund screener is a great way to select funds that meet your personal investment objectives.

VCSH – Vanguard Short-Term Corporate Bond ETF

• AUM: $37.7B
• 1mo Performance: -1.2%
• 1mo Flows: -$3.9B

LQD – iShares iBoxx Investment Grade Corporate Bond ETF

• AUM: $32.7B
• 1mo Performance: -5.2%
• 1mo Flows: $3.1B

JNK – SPDR Bloomberg High Yield Bond ETF

• AUM: $6.1B
• 1mo Performance: -0.4%
• 1mo Flows: $645m

Data for this article is as of October 24, 2022.

Please note this article is for information purposes only and does not constitute investment advice.