Vanguard Long-Term Corporate Bond ETF

Risk Classification: 4 – Aggressive

Price per Unit (1 Apr 16): 89.64 [USD]

Dividend Yield: 4.15%

Expense Ratio: 0.10%

Please refer prospectus for detailed risk disclosure

Investment Rationale:

This ETF broadly tracks the US long tenor corporate bonds. Since it invests in long tenor bonds, the price is more sensitive to interest rates and credit spreads than funds that invest in shorter tenor bonds.

We don’t expect a sharp sell-off in medium term US treasuries due to our overall bearish outlook and high yield differential with other G3 sovereign markets. Though the US Fed may raise short term rates in 2016, longer term treasuries will remain anchored as long term inflation expectations remain under check. Safer investments like US Treasuries and Agencies will do well in this environment.

We are already seeing this dynamic play out. US 30 year treasury yield differential with 3 year treasury yields is narrowing:

us 30 minus 3

This ETF has underperformed as credit spreads have widened out as US corporate balance sheets have deteriorated as managements have taken more shareholder friendly actions. Below chart indicates the widening in investment grade spreads. We don’t expect a significant widenening in credit spreads but there will be periods of volatility in 2016.

Below chart shows that valuations are attractive:

us ig spreads

Another way of spottting value in this ETF is comparing its price history with the 30-3 treasury spread. Historically we find that there was very accurate inverse relationship which has broken down in the recent past due to widening in the credit spreads which we talk about above. Below chart plots the VCLT US price with the inverse of 30-3 spread.

vclt and 30min3

Fundamental Risk to investment:

This ETF will sharply sell off in the event of a sharp widening in credit spreads in corporate credit from current wide levels and/or a sharp sell-off in US Treasuries. Neither are base case expectations. We do acknowledge that there will be periods of volatility in 2016 so the prudent strategy is to buy when spreads widen out.

Details of ETF:

Details on Vanguard website – For Live data and Prospectus