BondSavvy's Corporate Bond Returns

July 2022 Corporate Bond Returns vs. iShares Corporate Bond ETFs

We outperformed the iShares HYG high yield corporate bond ETF for 14 of our 28 (50%) high yield bond recommendations. We outperformed the iShares LQD investment grade corporate bond ETF for 14 of our 16 (87.5%) long-term investment grade bond recommendations. Thus far, all of our June 16, 2022 short-term bond recommendations have outperformed the iShares SLQD 0-5 year investment grade corporate bond ETF.

Key Drivers of July 2022 Corporate Bond Returns

A key driver of strong July 2022 corporate bond returns was the fall in US Treasury yields since they reached a peak on June 14, 2022. As shown in Figure 3, YTMs of the 2-, 10-, and 30-year Treasury all fell, with the 10-year US Treasury YTM falling the most: 82 basis points (or 0.82 percentage points) from 3.49% to 2.67%.

Figure 3: Year-to-Date 2022 US Treasury Yields

Credit spreads for many of our recommended corporate bonds fell as well. For example, the credit spread for High Yield Bond 5 fell 90 basis points (bps), from 5.38% on June 30, 2022 to 4.48% on July 29, 2022. This was a big driver of its strong July 2022 corporate bond return. The credit spread of High Yield Bond 1, July 2022’s best performer, fell 93 bps. This bond price increased more than that of High Yield Bond 5 due to Bond 1's longer-dated maturity.

CASE STUDIES OF CORPORATE BOND RETURNS FOR EXITED BONDSAVVY RECOMMENDATIONS

Many investors believe that 'interest rates' are the only thing that impact bond prices. We have two real-world examples that will hopefully dispel this notion once and for all.

On September 26, 2017, during the premier edition of The Bondcast, we recommended Verizon 3.85% 11/1/42 (CUSIP 92343VBG8) and Albertsons 7.45% 8/1/29 (CUSIP 013104AF1). Understanding the changes in these bond prices helps investors better understand what to look for when investing in bonds and what causes bond prices to rise and fall.

Verizon 3.85% '42 Case Study

Verizon is an investment-grade issuer, as its bonds are rated Baa1/BBB+ by Moody's and S&P, respectively. Bonds rated at least Baa3/BBB- are deemed 'investment-grade,' meaning that the credit rating agencies believe they have a lower risk of default than 'high-yield bonds,' which have lower ratings.

In the below chart, we compare changes in the price of the Verizon 3.85% 11/1/42 to its benchmark US Treasury 2.75% 11/15/42 (CUSIP 912810QY7). The reason it is called the 'benchmark' is that the maturity date of this Treasury bond is almost identical to that of the Verizon bond. The price of this US Treasury bond moves up and down based on the demand for this government bond. As the price for this Treasury bond increases or decreases, its yield to maturity ("YTM") moves in the opposite direction. The yield to maturity of this Treasury bond is telling investors what the 'risk-free' investment return is for a Treasury bond that matures 11/15/42, as the US Treasury is deemed to have no default risk. (We don't believe the US government has zero risk of defaulting, but that discussion is for another post.)

When the Verizon bond -- and nearly all other investment-grade corporate bonds -- are quoted on a trading desk, they will be quoted as a spread to the benchmark Treasury. This spread is referred to as the credit spread. For example, suppose:

Verizon 3.85% '42 YTM: 4.22%

US Treasury 2.75% '42 YTM: 2.89%

Credit spread:1.33%

The Verizon bond's YTM is the result of changes in the benchmark Treasury AND the credit spread. As Verizon's credit quality improves, its credit spread will typically shrink, as investors will require less return above the benchmark Treasury to compensate them for the extra credit risk they are taking. When the credit spread shrinks, the bond's yield to maturity decreases and the price of the bond increases. Similarly, if the benchmark Treasury yield moves up or down, that component of the Verizon bond's YTM will also move up or down.

A real-life example is shown in the below charts, which show bond price changes for the Verizon '42 bond we recommended September 26, 2017 and its benchmark Treasury. Since we recommended the Verizon bonds, they have increased in price 12.5 points, from September 26, 2017 through June 30, 2019, generating a total return of 21.4%, while the benchmark Treasury increased 4.3 points during the same time period. The Verizon bond price increase happened because the credit spread for these bonds shrunk, as Verizon has been reporting strong financial results. While moves in the '42 Treasury bond do impact the price of the Verizon '42 bond, the two bonds do not move in lockstep. In this case, Verizon's strong operating performance enabled the bonds to increase in price well beyond the price increase of the benchmark US Treasury bond.

Sources: Historical prices are from FINRA market data. The prices used to calculate the Verizon bond's total return are from Fidelity.com. Total returns include interest income accrued and/or received and capital appreciation. Returns do not contemplate re-investment of interest income. Total returns are not annualized returns.

Albertsons 7.45% '29 Case Study

Bonds rated below investment grade (aka 'high-yield bonds') do not trade in relation to their benchmark Treasury as shown in the below chart, which compares changes in the Albertsons 7.45% '29 bond (CUSIP 013104AF1) we recommended to its benchmark 6.125% 8/15/29 Treasury (CUSIP 912810FJ2). High-yield bonds are known as a 'credit investment,' and their price is driven by changes in the underlying credit quality of the bond issuer. For example, for the first half of 2017, the Albertsons bonds were trading at or above 96. Then, in June 2017, Amazon announced it was purchasing Whole Foods, and many investors thought Albertsons wouldn't be able to compete, which caused the bonds to fall into the 70s, at which point we recommended the bonds at 78.50 on September 26, 2017.

Since then, Albertsons has delivered strong financial performance, and the bonds increased in price 18 points from the date we recommended the bonds through June 30, 2019. You'll see the benchmark Treasury fell 2.4 points during this same time period, and movements in the prices in both bonds were not correlated.