Investors seeking a high-quality bond fund can find one in this 'solid' offering, says Morningstar

Published Fri, Dec 15 202311:41 AM EST

Investors looking to move into high-quality corporate bonds and avoid riskier high-yield assets may want to consider Vanguard's Intermediate-Term Investment-Grade Fund . The actively managed fund trades under the ticker symbol VFIDX for Vanguard's Admiral share class. It currently has a 30-day SEC yield of 5.34% and an expense ratio of just 0.10%, according to Morningstar. The fund is also one of just two intermediate-term investment grade bond funds in the Morningstar FundInvestor 500 list of top funds that have most of their assets in corporate bonds, said Paul Olmsted, senior manager research analyst at Morningstar . "It's a solid option" for those who want a fund that is largely made up of investment-grade securities, said Olmsted, who once was a taxable-bond trader and head of municipal underwriting and trading for Oppenheimer in Detroit. The Vanguard fund "is certainly much more of a pure strategy compared to some other active managers." VFIDX YTD mountain Vanguard Intermediate-Term Investment-Grade Admiral Shares year to date A majority of the fund's assets are in investment grade corporate bonds, but there is also exposure to investment grade structured products and investment grade emerging market sovereign debt, said Arvind Narayanan, senior portfolio manager and co-head of investment grade credit at Vanguard. "We want to stay true to what the fund's mandate is, which is to drive performance and income through exposure to investment grade securities," he said. High-yield assets, which offer more income in exchange for greater risk, typically only make up 1% to 3% of the fund. By contrast, the other intermediate-term fund on the Morningstar FundInvestor 500 list, PIMCO Investment Grade Credit Bond fund, has more than 10% in high yield, according to Morningstar. While the latest CNBC Fed Survey shows respondents see a higher probability of a soft landing than a recession, defaults are still a risk. Fitch Ratings is forecasting corporate high yield default rates to rise to 5% to 5.5% in 2024, up from 3% to 3.5% in 2023. "The reason companies are rated high yield is because they have so much leverage on their balance sheet and, into an economic slowdown, they are likely to be the companies that get themselves into more trouble than large-cap investment grade companies," Narayanan said. "That's why having that exposure to investment grade corporate bonds … at this point in the cycle is a tremendous value," he added. VFIDX also typically holds 5% to 10% in Treasurys to provide daily liquidity for investors, as well as for the fund's managers so they can take advantage of any mispricing in the market, Narayanan said. If there is a recession, high yield credit spreads will likely widen, which means the VFIDX can be a more defensive play, added Morningstar's Olmsted. "From that standpoint, it should hold up, and it has held up better in the past, when you look at some of those kinds of stress periods," he said. Meanwhile, the assets in the fund that are high yield are what Narayanan calls high quality, "mispriced securities." "Think of rising stars, such as a Ford or an Occidental Petroleum. Those are the types of names that have recently been upgraded back into the investment grade space," he said. "We tend to use that capacity in high yield to add to those types of issuers before the upgrade, anticipating the upgrade." Extending duration Intermediate duration is also a sweet spot right now, Narayanan said. When the Federal Reserve cuts interest rates, yields on short-term assets like Treasury bills, money market funds and high-yield savings accounts will also go down. On Wednesday, the central bank indicated the possibility of three rate cuts next year . "You definitely want to have extended duration in your portfolio," said Narayanan. VFIDX has an average duration of 6.1 years. "At the same time, you're sitting on very healthy current yields, which are very competitive with cash," the fund manager said.