Specialist fixed income ETF provider Tabula Investment Management says that recent market volatility has highlighted the importance of investment grade bonds as a source of income.
Over the past few years, investors have used high-dividend stocks to construct higher yielding portfolios, forgetting that companies can and do cut their dividends when revenues and incomes fall. Conversely, coupons on bonds are a legal liability and cannot be reduced in the face of adversity, unless a company goes into default.
When building an investment grade portfolio there are several key elements: the underlying bonds must be liquid; the exposure should be equally distributed across names and sectors; and finally, the maturity of the portfolio should target a relevant maturity and not vary over time due to new bond issuance trends.
In terms of liquidity, Tabula says investors in European fixed income funds should review their holdings to see what exposure they have to bonds that are likely to benefit from the European Central Bank's recently announced €750bn bond-buying programme.
Tabula says some popular indices used by fixed income ETFs have only around 50% exposure to these bonds, while 80% of the bonds in the index for its Tabula iTraxx IG Bond UCITS ETF (TTRX) are eligible for the program.
The ECB's €750bn Pandemic Emergency Purchase Programme (PEPP) announced in late March followed a €120bn expansion to ECB QE, meaning the Central Bank will buy more than €1.1trn worth of bonds between April and year-end.
"Faced with continued uncertainty, the argument to ‘buy what the bank is buying' has never been stronger. As the ECB's bond buying is likely to focus on the largest and most liquid issues, fixed income investors should review their funds to see how well placed they are to benefit from this intervention," said Tabula CIO Jason Smith.