Investment-grade bonds—returns and risks
U.S. investment-grade bonds can provide investors with a safe and steady income stream. They’re issued by the U.S. Department of the Treasury and corporates—for example, blue-chip companies like Comcast (or CMCSA) and Mondelez (or MDLZ). The issuers have a very high ability to service the debt issued. There’s little risk of default.
Popular exchange-traded funds (or ETFs) like the iShares 20+ Year Treasury Bond ETF (TLT) and the iShares 7–10 Year Treasury Bond ETF (IEF) provide exposure to U.S. Treasuries. Bond funds like the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) invest primarily in corporate investment-grade debt. LQD holdings include companies like Microsoft (or MSFT) and Intel (or INTC). Both companies are part of the PowerShares QQQ (QQQ). QQQ tracks the NASDAQ-100 Index.
Some funds, like the Vanguard Total Bond Market ETF (BND), provide exposure to U.S. Treasuries and high-grade corporate bonds.
This series will discuss primary and secondary market trends in the U.S. investment-grade bond market. For debt securities, issuers approach investors through the primary market. Treasury securities are sold to investors through a public auction process. Corporate borrowers issue debt through private placements. They can also market it to investors through underwriters or investment banks.
We’ll cover these trends for corporate bonds (Parts 4–5) and U.S. Treasuries (Parts 6–12).
Importance of Treasury yield movements
Although investment-grade bonds have low credit risk, they’re subject to interest rate risk. Interest rate risk occurs when bond prices fluctuate. Yield movements cause bond prices to fluctuate. Bond prices and yields move in opposite directions. When yields rise, bond prices fall and vice versa. Tracking yield movements is vital for bond investors.
Treasury yields also affect equity investors’ return expectations. Treasury yields provide estimates for the risk-free rate—a vital input for computing equity risk premiums. The yield curve also provides future inflation expectation estimates.
You’ll read a detailed analysis of the key drivers for U.S. Treasury yields in the next parts in the series.