I mentioned in an earlier article, published Feb. 24th, that even bonds and bond ETF’s are at risk in the current environment; primarily due to a phenomenon know as a widening of credit spreads.  This is happening in a big way now.  Compare to the original graph of   Baa Corporate bond spreads (the bond yield minus the Treasury bond yield) immediately below, to the tail end of the graph below that which is current.  Note how spreads have widened dramatically.

Moody’s Baa Corporate Bond Spreads Feb. 24, 2020

fredgraph (1)

Moody’s Corporate Bond Spreads March 17, 2020

Corp Bond Spreads Mar17-2020

What does this mean?  This means that corporate bonds held in pension fund, insurance company, bank portfolios, and ETF’s are losing money for investors.  The higher proportion of corporate bonds, the worse it is.  What might be considered a ‘safe’ strategy is being compromised by the arithmetic of bond pricing and credit ratings.

I had no predilection it would happen so quickly.  Here is a quote from my previous (prescient) article:

What might cause spreads to widen?  I’ve mention higher inflation expectations (and we’re seeing signs of rising inflation) but also deteriorating economic conditions (see previous articles) can be the culprit.  Different  portfolios of bonds (ETF’s, mutual funds, pension funds) have more or less invested in more credit-worthy government securities than others.  WHY?  Because if the manager wants to have a higher yield (to attract your money) then he must lower the quality of the bonds he holds in the fund.  This is why it makes sense to actually read the FAQ sheets and commentaries of the the funds you own.

credit-spread3To see how damaging the widening of spreads has been so far (and it will likely continue to get worse) I’ve included the price performance of the same two index funds I discussed in the Feb. 24th article.  The below compares the higher quality (more government bonds and highest quality corporates) BND bond index to the SPDR short term high yield index invested heavily in junk grade corporate bonds.



 

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About the Author

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.

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