IGLB: Down Big, But Not Done, Sell Rating Assigned

by Rob Isbitts.

iShares Long-Term Corporate Bond ETF (NYSEARCA:IGLB) is the type of exchange-traded fund (“ETF”) that may tempt some investors in the current environment. I am not one of them. This ETF is part of a peer group that continues to lure in those who believe that the recent spike in interest rates from near-zero levels has created a golden, long-term opportunity. I say, not so fast. While long-term bond rates may indeed have peaked, assuming that the coast is clear to lock in long-term maturities in BBB-rated securities is fraught with risk. I see too weak a reward/risk trade-off here, thanks to a corporate credit market that has still not resolved the damage from the 2008 financial crisis. I rate IGLB a Sell because while Treasury Bonds are getting closer to a potential buy zone, and corporate bonds are still an overpriced asset versus their continued risk.

Strategy

IGLB is an ETF that tracks the ICE® BofA® 10+ Year US Corporate Index. This fund invests in bonds issued by U.S. and non-U.S. corporations that typically mature in between 10 and 30 years from now.

ETF Grades

• Offense/Defense: Defense

• Segment: Bonds

• Sub-Segment: Corporate.

Technical Ratings

• Short-Term (next 3 months): D

• Long-Term (next 12 months): D.

Rating scale: A = Excellent, B = Good, C = Fair, D = Weak, F = Poor

For a detailed description of MII’s proprietary technical rating system, see disclosures at bottom of this report.

Holding Analysis

IGLB is loaded with fixed income securities. It owns over 3,400 separate bond issues. Nearly half of those (49%) are rated BBB, with most of the rest (39%) rated A. Another 10% fall into the higher AA category, and 2% of the fund is invested in AAA bonds, the highest quality rating. The entire portfolio matures in 10 years or more, with 55% maturing in 20-30 years. Most of IGLB (86%) is invested in U.S. corporate bonds, with the remainder primarily in Europe. Asian bond exposure is about 3% of this ETF’s asset base.

Strengths

I know my rating for an ETF is going to be on the weaker side when the main strength I can identify is the parent company that owns the fund. Blackrock’s iShares unit, the 800-pound gorilla of the ETF business, runs IGLB. That won’t prevent a potential selloff in the underlying 3000+ bonds the fund owns, but it does at least add some credibility on some level. IGLB is also quite liquid, with an average daily volume of over $25 Million and total assets under management of over $1.6 Billion.

Weaknesses

That is technically “investment grade.” But as has been documented by me and many others over the years, many bonds have long been the beneficiary of Wall Street’s version of “grade inflation.” That is, many BBB bonds are filled with very weak “covenants.” In other words, there are plenty of ways that the bond issuers can squirm out of their obligations to pay income or even principal (thus defaulting) to shareholders, should a localized or systemic credit crisis ensue. Many investors today do not think for a moment about BBB bonds being risky. But here is some evidence that they should think twice.

Above is a chart of the New York Fed’s Corporate Bond Market Distress Index. As you can see, it is currently tailing off from its highest point in the past 18 years, except for the 2008 and 2020 market calamities. The bond market is stressed. And we have had some false alarms. We may have more in the future. But this market is in a spot where just a small disruption could reveal the risk that many BBB-rated bonds get away with. In reality, many of those bonds should be BB-rated or lower. But if that were to occur, it would force a massive amount of selling by large investment institutions who cannot hold bonds rated less than BBB. Hopefully you get the picture: a credit “event” can occur at any time. If it does, it could rival that of 2008. And even if it doesn’t occur any time soon, that does not mean the risk imbedded in BBB bonds is not very high.

Opportunities

The bond market is a very fickle place these days. Prices vault up and down in a way that rivals the stock market. This is all because of the “high class problem” created by suddenly higher interest rates, thanks to multiple Fed rate hikes last year and again to start this year. As such, a sudden plunge in bond prices could put this BBB-heavy ETF in a position where its portfolio reaches an extreme level of undervaluation. The average price of the bonds in IGLB is around $92, and the weighted average yield on the bonds in the portfolio is over 5.6%. Those are attractive numbers, but only if the concerns above can be dismissed. To this point in the bond market cycle, I am not willing to dismiss them.

Threats

Asset manager Janus Henderson recently said what I am thinking and anticipating. In a statement earlier this week, the firm said this:

“Corporate financial health will worsen across the globe this year, failing to gain respite from signs that inflation has peaked and hopes for an economic soft landing.” The firm’s global credit risk monitor’s indicators – debt loads, access to capital markets, cash flow and earnings – all flashed red in the fourth quarter of 2022, signaling caution to investors.”

IGLB is an ETF that invests from the 10-year maturity range out to 30 years or more. But as of now, the vast majority of the portfolio is in bonds maturing in 20 years or longer. That’s a ton of credit and longevity (i.e., duration) risk. It is too much for me right now.

Conclusions

ETF Quality Opinion

Many ETFs I write about are intended to shine a light on securities that I will consider owning when I think the price and time is right. That might occur here, but I think its a longshot for a while.

ETF Investment Opinion

There’s just too much uncertainty remaining in the credit markets. Too many corporations are “zombies,” surviving only because they can issue more debt when their existing debt matures. That creates a risk of a collapse in corporate bond prices, as confidence quickly erodes. We have seen it before, and in today’s emotionally-charged, algorithm-driven market, there is heightened risk we’ll see it again. I have no idea when. And US Treasuries yield plenty, and thus offer strong competition versus taking credit risk. So, I’m not sitting around in ETFs like this one, just to find out when the credit event will happen. It may be too late to react by then. I rate IGLB a sell.

Modern Income Investor’s proprietary technical rating system was created by the firm’s founder, Rob Isbitts, a chartist for more than 40 years. The ratings emphasize risk-management, and the belief that while any investment can appreciate in price at any time, each investment carries a different level of potential for major loss. The balance of reward and risk is calculated each night for thousands of securities, using a formula that analyzes price trend, strength of that trend and key price levels. It analyzes data over multiple time frames to produce a short-term rating (looking 3 months out) and a long-term rating (looking 12 months out).