SPDR Portfolio Intermediate Term Corporate Bond ETF (NYSEARCA:SPIB) has a portfolio of U.S. investment grade corporate bonds. The fund offers attractive yield of nearly 6%. The fund has a quality portfolio of investment grade bonds with low default rates. Unlike treasuries that typically holds their prices quite firm in an economic recession, SPIB’s fund price will likely fall. Hence, it may still be too early to buy SPIB now. Once an economic recession arrives, investors should treat the decline in SPIB’s fund price as a good buying opportunity to accumulate more shares.
SPIB has not performed well since 2021
Prices of bonds are sensitive to the rise and fall of interest rates. SPIB is no exception. Its fund price has reached its historical peak during the pandemic thanks to the Federal Reserve’s nearly 0% rate policy. However, SPIB’s fund price fell sharply as the Federal Reserve quickly reversed its rate policy due to sky-rocketing inflation that started in late 2021. As a result, SPIB has declined by about 15.6%. Its loss of 15.6% was not the worst though. SPIB’s peer fund such as SPDR Portfolio Long Term Corporate Bond ETF (SPLB) suffered a much greater loss of 37.7% due to SPLB’s longer average duration of the bonds in its portfolio. For reader’s information, the longer the duration of the bond, the more sensitive its price is to the change of rate and vice versa. Hence, SPLB fell much more sharply than SPIB. In contrast, SPIB’s shorter duration peer, SPDR Portfolio Short Term Corporate Bond ETF (SPSB) has only dropped by 6.8% due to its portfolio’s shorter duration characteristic.
SPIB owns a portfolio of investment-grade corporate bonds
SPIB has a portfolio of investment grade corporate bonds. As can be seen from the chart below, 99.95% of its total portfolio consists of investment grade corporate bonds that are rated BAA or above. For reader’s information, BAA-rated bonds or above are considered investment grade bonds. These bonds have very low default rates. In fact, default rate for 3-years and 10 years investment grade corporate bonds are only 0.41% and 1.81% respectively. Since the current 30-day SEC yield of 5.95% is much higher than these default rates, the risk of default is quite negligible for investment-grade bonds.
Despite its low credit risk, SPIB’s fund price may still fall sharply in market turmoil
Although, SPIB has low credit risk, its fund price can be quite vulnerable if the market is in panic modes. As can be seen from the chart below, SPIB’s fund price experienced negative spikes amid the initial outbreak of the global pandemic in 2020 and during the Great Recession in 2008/2009. In contrast, its treasury fund peer SPDR Portfolio Intermediate Term Treasury ETF (SPTI) did not experience any sharp declines during these two market turmoil. The reason is due to the fact that investors often perceive U.S. treasuries as risk-free assets and tend to rotate money out of riskier assets and buy U.S. treasuries instead. Even though SPIB has a portfolio of investment grade corporate bonds, it is still perceived as a riskier asset relative to U.S. treasuries.
This negative spike is actually a good buying opportunity
We have observed two negative spikes during the past two recessions. However, investors need not be feared as these are good buying opportunities especially for investors with a long-term investment horizon. As the chart above shows, in the market turmoil in 2020, investors can purchase the fund at a 12% discount. Based on the past experiences, these negative spikes often revert to normal quickly. Hence, income investors should not miss these rare opportunities to accumulate shares.
SPIB has also outperformed its treasury peer SPTI by a large margin in the long run. As can be seen from the chart, its long term total return of 60.7% since 2009 was much higher than its treasury peer SPTI’s 20.4%. If investors can take the opportunity to invest during the negative spike during market turmoil, the difference in return between SPIB and SPTI will be much greater in the long run.
An economic recession may not be too far away
We believe the Federal Reserve’s policy of keeping the rate elevated and longer to combat persistent inflation may eventually tip the U.S. economy to a recession. The reason that it has not happened yet is because monetary policy typically takes a year or longer to transmit through the economy. The impact will likely be felt towards the end of the year. We may eventually see a recession in the first half of 2024. As an economic recession arrives, earnings revision will be revised downward and this may trigger market selloffs. Hence, we anticipate a negative spike in SPIB’s fund price in the upcoming recession. Long-term investors should especially embrace the volatility and accumulate shares of SPIB at that time.
We like SPIB’s attractive yield and better long-term returns than U.S. treasuries. However, we anticipate SPIB will drop further in the upcoming recession and patient investors may want to wait till that time to buy more shares.
Additional Disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.