A Compelling Option for Exposure to Investment-Grade Corporate Bonds

IShares Broad USD Investment Grade Corporate Bond ETF USIG is a solid choice for investment-grade corporate-bond exposure. This market-value-weighted fund is one of the cheapest in the corporate-bond Morningstar Category, which makes it a compelling option. The fund earns a Morningstar Analyst Rating of Silver.

The strategy tracks the ICE BofAML US Corporate Index, which includes U.S. investment-grade corporate bonds with at least one year to maturity. Qualifying issues must be fixed-rate and have at least $250 million in outstanding face value. The index is market-value-weighted, which pulls the fund toward the largest and most liquid issues.

A passively managed, market-value-weighted index fund is a sound approach for exposure to the investment-grade corporate-bond market. It ensures that the fund accurately captures the risk and return characteristics of its opportunity set by free-riding the market's collective wisdom to determine the relative value of each of its holdings. There is less room for active managers to find an informational edge here than in the high-yield bond market because the market knows with greater certainty what investment-grade bonds' future cash flows will be.

There are criticisms against the merits of market-value-weighting, because it assigns the largest weights to firms with the most debt. While issuer activity dictates the composition of the portfolio, the largest issuers tend to have the most resources to service their debt. For example, at the end of June 2020, the three largest issuers in the portfolio were JPMorgan Chase JPM, Bank of America BAC, and AT&T T.

Although the fund limits its exposure to investment-grade-rated debt, it courts a fair amount credit risk. As of June 2020, 90% of its assets were rated BBB or A. While this does leave the portfolio susceptible to losses when credit spreads widen, it is an accurate reflection of the composition of the investment-grade corporate-bond market. For instance, while the strategy fell by 12.67% between Feb. 19, 2020, and March 23, 2020, the peak-to-trough period of the coronavirus crisis, the average fund in the corporate-bond category fell by 12.60%.

Despite pulling in thousands of bonds and nearly as many issuers, the strategy has successfully tracked its bogy. Its tracking error over the three years through May 2020 was just 0.15%.

People BlackRock boasts a large and experienced team reinforced by sector specialists, support teams, and centralized trading desks, mitigating key-person risk and underpinning an Above Average People rating.

James Mauro and Scott Radell have acted as the fund's lead portfolio managers since 2011 and 2010, respectively. Mauro joined BlackRock in 2010 after acting as a portfolio manager at State Street for over 17 years, while Radell joined BlackRock in 2008. They lead a broader team of sector-specialist portfolio managers who are supported by a handful of analysts, as well as a separate trading team and an index research team. This specialization improves execution and scalability, allowing BlackRock to deliver high-fidelity index tracking in a cost-efficient manner. The scope of responsibility is most broad for the senior members of the team, who are responsible for BlackRock's macro outlook and for strategic research, while the specialists beneath them are responsible for the day-to-day operations of the strategy, such as processing creation/redemption baskets.

The managers' compensation is tied to performance, as measured by the tracking difference between the fund and its benchmark. This aligns their interests with investors'. Additionally, BlackRock's risk and quantitative analysis team provides independent oversight.

Process This portfolio replicates the composition of the U.S.-dollar-denominated, investment-grade corporate-bond market, effectively harnessing the market's collective wisdom about the relative value of each bond. This is a sound approach because it is cost-effective and promotes low turnover, and also because the market does a decent job pricing these bonds. It earns an Above Average Process Pillar rating.

The fund employs representative sampling to track the performance of the ICE BofAML US Corporate Index, which includes corporate bonds with at least one year to maturity. Qualifying issues must be fixed rate and have at least $250 million in outstanding face value. The index is market-value weighted, which free-rides the market's collective wisdom to find the relative value of these securities. While this allows issuing activity to dictate the fund's exposure, it also accurately captures the characteristics of the investment-grade corporate-bond market.

Prior to August 2018, the fund tracked the Bloomberg Barclays U.S. Credit Bond Index, which included both corporate and supranational debt. BlackRock adopted the fund's current index to isolate exposure to corporate debt and because it is a more common benchmark for active managers in the category.

Portfolio Reflecting the composition of the investment-grade corporate-bond market, the fund courts a fair amount of credit risk. As of January 2020, approximately 51% and 38% of its assets were invested in bonds rated BBB and A, respectively. Those tiers sit at the low end of the investment-grade quality spectrum.

In the aftermath of the 2008 financial crisis interest rates fell to nearly zero, which prompted corporations to issue debt to take advantage of the historically low rates. The entire corporate-bond market grew, but BBB rated bonds became a bigger part of the market. According to BlackRock, BBB rated corporate bonds consistently represented just approximately 25% of the investment-grade corporate-bond market between 2005 and 2009. However, from 2009 and 2013, that amount jumped to approximately 40%, and it has grown steadily toward its current amount of 50%. While the fund's credit risk is generally in line with its category peers, the dominance of the lowest-rated investment-grade-quality debt makes the fund vulnerable widening credit spreads.

The fund maintains a tilt toward the financials sector, which represented over 20% of its assets at the end of January 2020. Although the fund could suffer if this sector struggles, its holdings are in line with the category norm. Similarly, the fund's duration of 7.5 years is also in line with the category median.

Performance The fund's performance during the trailing 10 years through January 2020 was unremarkable. It trailed the category average by 13 basis points annually, a middle-third ranking.

Prior to August 2018, the fund tracked an index that included supranational debt, and the fund consistently held approximately 5% of its assets in bonds issued by supranational agencies as a result. Investment-grade corporate bonds outperformed supranational agency bonds during the trailing 10 years through January 2020, which explains the fund's category-relative performance, as it was consistently 4.50% overweight supranational debt. The ICE BofAML US Corporate Index outperformed the Bloomberg Barclays Global Aggregate Supranational Index by over 3 percentage points. The fund's performance has improved since it switched to the ICE BofAML US Corporate Index; it has beaten the category median by 39 basis points, with similar volatility.

While there is less room for active managers to find an informational edge with investment-grade corporate bonds relative to riskier assets, the fund's active peers may dip into high-yield territory, which could slightly boost their returns. The average fund in the category holds 6% of its assets in below-investment-grade debt. In contrast, this fund is forced to sell when its holdings are downgraded below this threshold, which could slightly hurt performance, as similar forced selling could cause these bonds to become undervalued.