Exchange traded funds (ETFs) have really opened up corporate bonds to individual investors, and there are now a plethora of different corporate bond ETFs which investors can purchase. They range from short-dated bonds, investment grade and high yield debt (historically known as ’junk bonds’), to bond ETFs that exclude certain sectors such as financials.
The majority of corporate bond ETF factsheets provide their holders with a series of statistics on the underlying holdings within the ETF. However, as with many products from the world of finance and investments, there is an infuriating number of ways to calculate rather similar-sounding portfolio characteristics.
From the perspective of an investor, who wants to make a judgement on whether they should purchase an ETF, the most important numbers are Yield to Maturity (YTM),
Effective Duration and Credit Quality. In addition, and unfortunately this is rarely stated, is the Option Adjusted Spread (OAS) which is used to determine the excess return over comparable government bonds that an investor may receive from taking on company credit (or default) risk.
In the next few paragraphs we outline how you should interpret these measures, when you assess whether or not to purchase a corporate bond ETF.
Yield to Maturity
YTM is the yield that an investor purchasing the ETF today would receive before any defaults, while the Yield to Worst (YTW) accounts for call provisions within the bonds and is always slightly lower. For example, a holder of the iShares Core GBP corporate bond ETF (SLXX) would receive a YTM of 2.2% if the bonds were held to maturity (as of 9 June 2017) and there were no defaults.
To look at the historic YTM of this ETF, we used data from the Bloomberg GBP Corporate Bond Index in Chart 1 which has very similar underlying holdings. Since 2010, the YTM of the index has fallen from 5% to 2.2%, meaning that investors will receive a lower return on an ongoing basis than they would have done before.
Chart 1: Bloomberg GBP Corporate Bond Index – Yield to Maturity