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
Moody’s Corporate Bond Spreads March 17, 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.
To 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.