The 30-year treasury yield has failed to breach the 1.5% mark for any longer than a day or two since June 2020. As I watch interest rates stay low, even as we move through the thick of the COVID-19 crisis, I can’t help but think about income-seeking investors. In the current environment, it has become increasingly hard to generate regular payments off a conservative portfolio.
That is when the Vanguard Long-Term Corporate Bond ETF (NASDAQ:VCLT) crossed my radar. Today, I take a closer look at this fund and assess the pros and cons of owning it as an income play.
Credit: Investor’s Business Daily
What VCLT is
Vanguard Long-Term Corporate Bond ETF is a fund of over 2,000 investment-grade corporate bonds (only 0.2% allocation to treasuries, likely for liquidity purposes only) with average effective maturity of nearly 24 years. The two graphs below depict the portfolio’s profile, both from an industry and credit quality perspectives.
Compared to other, more diversified bond funds, VCLT is not one of the largest in the market: $5.8 billion in net assets is about 12 times smaller than the iShares Core U.S. Aggregate Bond ETF (NYSEARCA:AGG). However, it is one of the main corporate-only, investment-grade, longer duration funds available. VCLT trades an average of about $70 million worth of shares per day, making it quite liquid for retail investors.
Source: DM Martins Research, data from Vanguard
Let’s take a look below at some of the main reasons why income-seeking investors might want to buy (or avoid) shares of VCLT.
- The main reason for owning VCLT, in my view, is the yield to maturity of 3.0%. In the current zero-rate environment, it is very hard to find these levels of recurring income without having to expose a portfolio to substantially riskier asset classes – e.g. high-yield junk bonds or commercial real estate.
- Distributions (1) are made monthly instead of quarterly, and (2) have been consistent, fluctuating within a tight range of 27 and 35 cents per share per month over the past 18 months at least.
- Management fee of 0.05% per year is affordable, to say the least. This is an important feature of the ETF, in my view, since yields are too low to justify a higher price tag.
- While volatility has been significant since the fund’s 2009 inception, at 11% annualized standard deviation of the daily returns, VCLT has never stayed underwater for very long. Even in March 2020, when the ETF experienced a painful correction of 28% from the peak, it returned to within striking distance of its all-time high by early April. The graph below helps to visualize VCLT’s resilience since inception (in blue; red is the Dow Jones Industrial Average).
Source: Portfolio Visualizer
- The flip side of the yield argument above is that VCLT’s 3% is far from being great. While I believe that the ETF strikes a good balance of quality and interest payments, the more risk-tolerant investor can find much better income opportunities elsewhere – especially if the investment universe is expanded beyond bonds to include dividend-paying stocks, REIT and even covered call funds.
- VCLT’s assets are very concentrated in (1) the lowest investment-grade tier, at a 50% allocation, and (2) procyclical sectors of the economy, at an 86% allocation to industrials and financial services. Should the fundamentals of the economy deteriorate substantially, a repeat of the March 2020 crash in corporate bonds would not be completely out of question.
- From a total return perspective, VCLT has not quite stood out. Since inception, the ETF has produced about 8% in annualized returns, volatility of nearly 9% and correlation with the stock market at almost 0.2. On the other hand, a 40/60 portfolio allocated to the Dow Jones (DIA) and long-term treasuries (TLT) (effectively a blend of interest payments and corporate exposure, see graph below) would have done better on all of these metrics. Therefore, in exchange for higher and safer interest payments, VCLT has performed poorly over time relative to other conservative investment strategies.
Source: Portfolio Visualizer
For certain investors, I believe that the Vanguard Long-Term Corporate Bond ETF might be worth consideration in the current zero-rate environment. The fund offers a decent 3% yield without giving up too much in credit quality.
However, if an investor’s goal is anything but to produce monthly streams of cash, other alternatives could be more compelling. A simple blend of stocks and bonds, for example, which provides (1) some downside protection through safer fixed-income instruments plus (2) upside exposure to Corporate America, may continue to produce better returns (absolute and risk-adjusted) going forward.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.