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ETF Specialist

Owning Big Debtors Doesn't Mean More Risk for These Bond ETFs

Market-value-weighted bond ETFs will not be crushed by the large debt loads imposed by their indexes.

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Market-value-weighted corporate-bond index funds are naturally biased toward the largest debt issuers. It may seem intuitive to conclude that the largest debtors are the riskiest, which has led to the idea that these index funds are poor investments. This notion is inaccurate, particularly in the investment-grade realm. The largest issuers tend to be large enterprises with the cash flow necessary to support their debt. They are not necessarily more leveraged or riskier than smaller issuers. The bond origination process, which takes investor demand into consideration, also helps prevent companies from issuing too much debt.

From 2007 to 2017, the largest 10 U.S. corporate issuers' median leverage, as measured by debt/EBITDA, was on par with the median leverage of all publicly traded U.S. issuers, according to estimates by Goldman Sachs. The median leverage ratio for the largest 10 issuers hovered slightly below 3.0 times, and the corresponding figure for all publicly traded issuers was slightly above 2.5 times.

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Phillip Yoo does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.