Compelling All-In Yields In Short Duration IG Bonds

By Matthew McGinnis

Investors in short-duration corporate bonds can capture 80% of the yield of the corporate Index while taking less than 25% of the interest rate risk.

Short-duration investment-grade corporates generally are providing attractive all-in yields due to the rise in front-end interest rates and widening of corporate spreads.

As the Federal Reserve has shifted to a more aggressive tightening posture, we believe that the market has increasingly priced in additional future hikes, prompting a repricing of the front end of the Treasury curve: Generic two-year and three-year Treasury notes have risen 176 basis points year-to-date, compared to 127bps and 91bps, respectively, for 10- and 30-year Treasuries (as of March 8).

Although off their wides for the year, short-duration IG corporate spreads have increased due to uncertainty around Fed policy, continued geopolitical risks, and historic levels of corporate issuance. All told, the Bloomberg Barclays 1-3 Year Corporate OAS has widened 20bps year-to-date.

These higher interest rates and wider credit spreads have resulted in attractive all-in yields. The Bloomberg Barclays 1-3 Year Corporate Index has had an average yield of 1.71% over the last 10 years – today, it is 3.14%. With the exception of a four-month period in late 2018 – 2019, as well as March 2020, the yield of the index has not been this high since 2009.

In addition, we believe the segment is attractive now due to its yield relative to interest rate risk. The Bloomberg Barclays 1-3 Year Corporate Index has a duration of 1.88 years and a yield of 3.14%, while the Corporate Index has a duration of 7.98 years (six years longer) and a yield of 3.91% (only 74bps higher). In other words, this index data suggests that investors in short-duration corporate bonds can potentially capture 80% of the yield of the Corporate Index while taking less than 25% of the interest rate risk. By comparison, over the past 10 years, on average, investors only captured 56% of the yield on the Corporate Index with 26% of the interest rate risk.

We are seeking to capitalize on these attractive all-in yields by adding short-duration IG corporates incrementally to portfolios.

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