iShares Investment Grade ETF (SLQD) Is Best Avoided While The Debt Ceiling Issue Goes On

The iShares 0-5 Years Investment Grade Corporate Bond ETF (NASDAQ:SLQD) is a way to get exposure to a relatively short duration, high credit rating corporate bond portfolio through your stock account. This avoids having to go through a broker-dealer network with high transaction costs to buy a bond directly. However, we think that while an efficient, low cost instrument to speculate on yields with, the SLQD exchange-traded fund (“ETF”) is not right for this moment in time.

We think the debt ceiling crisis should not be ignored this time around, even if it is just a speculative factor, and that markets may be getting ahead of themselves with rate progression. SLQD is still high enough duration to get hurt, and appears to us to be an unforced error now with potentially better timing in the near future. Longer-duration instruments make more sense if you don’t want to trade in and out of positions and micromanage returns, even though timing them would give even more total return opportunities.

SLQD Breakdown

In terms of sectoral exposures, the bonds in SLQD are substantially from well capitalized and high credit quality banking institutions like JPMorgan Chase (JPM), and otherwise the exposures are to consumer non-cyclical companies. Expense ratios on this ETF are very low at 0.06%, and certainly cheaper than buying bonds directly.

The duration is, of course, a critical metric at 2.2 years, telling us how sensitive the value of the portfolio here is to changes in interest rates. 2.2 is a relatively low duration.

Summing Up

Low duration isn’t exactly what we want. Our house view is that economically we are reaching a state, certainly in the U.S., where rates are likely peaking, both inflation and interest rates. We are lapping 2022 inflation figures, and supply chain issues have eased massively as the European and Chinese economy both take a breather. Clearly, this favors high-duration instruments that will be most sensitive to a decline in rates from extraordinary levels that we believe the market has incorporated as a new normal.

However, 2.2 years happens to still be high enough to take a hit on two factors. The first is that while unlikely, if lacking political consensus becomes a speculative factor against the Treasury’s credit rating, rates could go up across the board as the U.S. rate gets a premium. This has happened in the past on a technical glitch in the accounting systems, which is much less structural than an issue of political divide. A 2.2 year duration is enough to feel the pain of a falling interest in the U.S. credit institutions, but also not a long-term enough view where you can sit back and comfortably see coupons that are somewhat high and not take a trader’s approach. Of course, you could benefit much more by timing a longer duration bond ETF than a shorter one, assuming we get a premium on U.S. rates as the debt crisis evolves.

The second reason is more general and less topical, and that’s just that the Fed has said it’ll be hawkish and keep rates higher till the specter of perpetual inflation is no more. While markets are assuming the Fed will placate markets desperately, they likely won’t, and rates will stay higher longer than expected. Better deals could potentially be gotten with some waiting.

Overall, we think this debt ceiling crisis will pass, but fixed income in general isn’t very attractive while markets dismiss the danger of the debt ceiling crisis off-handedly.