Credit risk

IUSB has minimal credit risk, but duration is an issue (NASDAQ:IUSB)

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The iShares Core Total USD Bond Market ETF (NASDAQ: IUSB) is one such bond ETF that the concerned investor might consider right now to defend against the impending recession. Employment is on stilts as consumer confidence plummets. Economic conditions invite further rate hikes, and the state of the economy could deteriorate significantly. High credit ratings are a security, but pay attention to the duration of fixed income instruments, IUSB has quite a few.

IUSB Breakdown

From a credit quality perspective, we trust the strong bias towards AAA. Credit risk is non-existent.

IUSB credit type

Credit Profile (iShares.com)

From a maturity perspective, many bonds have durations of 7 to 10 years in the portfolio.

IUSB maturity

Deadlines (iShares.com)

Naturally, the coupons help reduce the effective duration which averages on a weighted basis around 4.9 years according to the detailed holdings.

The ETF’s current year-to-date decline is around 10%, implying that with a 4.9x sensitivity to rate hikes, the implied rate hike is 2% since the start of the year. beginning of the year, which is in line with the announcements made by the Fed during its meetings: two increases of 75 bp plus one slightly more since the beginning of the year.

Economy

The Fed has already made clear its stance on inflation that it will not tolerate it. With unemployment still very low and inflation still high, the economy invites further rate hikes. Part of the reason for continued employment and inflation is business optimism. Consumers have indeed received the memo on the economy. They’re spending a lot less, at least compared to pandemic highs, but companies are still hiring. If recent employment is on weak stilts, then we could get rate hikes on top of the already peak employment based on rate levels a month or two ago. This makes it more likely that the Fed will reverse course, which would actually be good for IUSB investors, but regardless of rates going up, and we think a 10% drop since the start of the year is too low given the duration of the portfolio. The ETF should have been more sensitive to the current rises.

From a yield perspective, the average coupon for this ETF isn’t very good either at 2%. Although the fee is low at 0.07%, it eats away at this yield. The YTM is around 3.2%, but again, it’s not doing the ETF a lot of favors. With benchmark rates soaring even beyond 3% on short-term Treasuries, which don’t have that duration risk, the 3.2% with duration risk is unattractive. While over time the effective maturity will decrease, there is always the loss of economic value by having harvested a lower yield than you could have. Overall, the duration risk makes this unattractive. We don’t know if we’re getting to a new base rate level. Don’t bet on a reversion here, and certainly realize that rates are very likely to rise for a bit longer at least.

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