The Federal Reserve will start buying ETFs on Tuesday. Here's how to ride its coattails

Published Tue, May 12 20206:57 AM EDTUpdated Tue, May 12 20207:36 AM EDT

Jesse Pound @/in/jesse-pound @jesserpound

The Federal Reserve will begin buying exchange-traded funds holding corporate bonds for the first time ever on Tuesday to support the credit markets pressured by the coronavirus crisis. The central bank announced late Monday it will buy "U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. corporate bonds." The Fed would not specify exactly which ETFs it would buy. Ned Davis Research identified funds to help investors follow the central bank. The central bank will be able to invest $250 billion in the secondary market. That amount of firepower, combined with a rule that limits its holdings to no more than 20% of a fund's shares, may mean the Fed will mainly buy only the largest funds, according to Ned Davis Research. "Given the potential size of the Fed's purchases, we expect them to initially focus on the largest investment grade corporate ETFs," Ned Davis analyst Matt Bauer said in a note last week. That may make the iShares iBoxx Investment Grade Corporate Bond ETF , which has more than $45 billion in assets under management, a main choice for the Fed, the note said. For the bonds of individual companies, the companies must have been investment grade as of March 22 and must mature within five years. The ETF purchases do not have a maturity requirement, but the Fed may choose to mirror those rules in deciding what to purchase, the note said. That may lead the central bank to prefer funds like the Vanguard Short-Term Corporate Bond Fund and the iShares Short-Term Corporate fund over the larger fund. "The sheer size of LQD makes it a likely candidate, however, its average maturity of over 13 years, makes short-term funds like VCSH or IGSB better suited to the Fed's implicit time-frame," the note said. All three of those investment-grade funds sold off dramatically in March but snapped back after the Fed announced its new facility. They are down less than 2% for the year. Among high-yield funds, the iShares iBoxx High Yield Corporate Bond fund, which has more than $20 billion in assets under management, is a potential pick by the Fed, according to the note. That fund also recovered some of its losses from a deep sell-off in March but is still down 9.3% for the year as investors worry that the the economic slowdown could cause a wave of bankruptcies.

Federal Reserve Chairman Jerome Powell

Kevin Lamarque | Reuters

The Federal Reserve will begin buying exchange-traded funds holding corporate bonds for the first time ever on Tuesday to support the credit markets pressured by the coronavirus crisis.

The central bank announced late Monday it will buy "U.S.-listed ETFs whose investment objective is to provide broad exposure to the market for U.S. corporate bonds."

The Fed would not specify exactly which ETFs it would buy.

Ned Davis Research identified funds to help investors follow the central bank.