“The bond market is the grease that makes the wheels of the economy turn,” said Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research. “It is how businesses, the government, the banking system get funded. What the Fed is doing is to try and keep the wheels turning.”
So far, it has been working. After the Fed’s intervention in the credit markets, bonds rallied in late March to put most bond funds that focus on investment-grade issues into positive territory for the quarter.
The Fed’s intervention was especially calming for bond E. T. F.s, where the share price can trade above or below the value of the underlying bonds, which is called the net asset value. Typically, E.T.F. fund prices closely track the N.A.V. During the sell-off, bond E.T.F. prices traded at big discounts, which was of concern for short-term traders, though not something long-term investors need to worry about.
Ms. Jones suggests following the Fed’s lead as the coronavirus crisis continues to unfold. “Buying what the Fed is buying is not the worst investment strategy.” Initially, in March, that only included investment grade bonds. In early April, the Fed announced that it would extend its support to high-yield bonds as well.
Most core bond index funds and E.T.F.s stick to investment grade. For long-term investors using bonds to provide diversification when stocks fall, “a high-quality core intermediate term fund is a fine place to be,” says Amy Arnott, portfolio strategist at Morningstar. “But you want to check that your fund is not dipping into below-investment-grade,” given the dark economic storm clouds.
Morningstar divides core bonds into two groups, those that strictly track an investment-grade index such as the Bloomberg Barclays U.S. Aggregate Index, and those that have some leeway to stray from the index, which are designated “core plus.” At year-end, the average intermediate core bond fund had less than 5 percent in bonds rated below investment grade, and the average intermediate core-plus bond fund had more than 10 percent.
One risk with all core bond funds that track the Bloomberg Barclays U.S. Aggregate Index is that half of the benchmark’s corporate bond holdings are issues that are rated BBB, which is the lowest rung within investment-grade bonds. If a BBB-rated bond issuer struggles to stay current with payments during this economic crisis, its rating could be lowered, effectively sending it off the edge of the investment-grade cliff into “junk” bond status. That concern grew in March; the debt of S&P 500 companies with BBB ratings fell nearly 15 percent.