Buying LQD At A 7.5% Discount Via Invesco Bond Fund (NYSE:VBF)

established theory

Invesco Bond Fund (New York Stock Exchange: VBF) are CEFs in the Invesco family. The vehicle is primarily income-oriented and holds investment-grade US Treasuries. The fund started his IPO in 1970 and has had quite a track record.

VBF is overweight U.S. investment grade bonds and immediately recalled the iShares iBoxx Investment Grade Corporate Bond ETF (LQDs). LQD is an ETF while VBF is a CEF, but the two vehicles are very similar. Let’s take a closer look at the two funds.

We can see that the two vehicles have very similar total return profiles over the 3 and 5 year lookback periods. Surprisingly, VBF has a low standard deviation (a measure of volatility). The main difference (out of structure) between the two funds is the fact that VBF is below investment grade bonds and he has a 20% bucket. This slice was expected to lead to higher VBF volatility. Note that VBF currently has no leverage.

This year saw a major rate hike, with the Fed raising the Fed Funds rate for the fastest time ever.

At current levels and where the market is setting terminal rates, revealing attractive yields has allowed investment grade bonds to “get back into the game.” Many market analysts are now commenting on why investors are asking more questions about bonds than about stocks. Somehow that’s to be expected after a decade of barrel bottom yields.

VBF is an interesting construct, exposing very similar builds to LQD and doing very similar analysis. However, VBF is a CEF and is trading at a -7.5% discount as the market sells bonds in 2022. The market will normalize. It turns out that VBF is a clear alternative to LQD. In this case, the investor can expect a 4% “up” from the discount to his NAV contraction in 2023. The only downside risk for VBF portfolios is a severe and prolonged economic recession, which could actually lead to defaults on the portfolios and higher credit risk compared to LQDs.

Holdings

The fund holds primarily investment grade bonds, with a small bucket made up of junk bonds.

Since the fund’s primary focus is investment grade bonds, it is speculated that some high-yield companies are “fallen angels,” i.e., securities that have been downgraded from investment grade.

From a sectoral perspective, the fund is well diversified, but has a high allocation to banks, exceeding our recommended 15% threshold.

The second largest industry group turns out to be Communication Bonds.

The term of the fund is 7.2 years.

The main points of VBF compared to LQD are:

• Similar duration profile (7.2 years for VBF vs. 8.3 years for LQD)
• Similar weighted average rating profile (BBB has a bucket around 50%, but LQD has no junk bonds)
• Neither fund is leveraged

performance

VBF down 25% year-to-date:

CEF will underperform LQD in 2022. However, over the three-year time horizon, both funds perform similarly.

VBF has more volatility, but on a 5-year basis the story is similar.

Let’s take a look at the risk/reward metrics.

• Standard deviation (5Y): 7.8 for VBF, 8.54 for LQD
• Sharpe ratio (5Y): 0 for VBF, 0 for LQD
• Beta (5Y): 1.33 for VBF, 1.59 for LQD

Distribution

Funds tend to use their asset cash flows primarily for distributions.

The fund currently has a 5% yield on LQD’s 5.8% SEC yield.

Premium/discount to NAV

Because the VBF is structured as a CEF, its collateral value does not always trade at the same level as the stock price.

From the table above, we can see that VBF typically trades at a 3% to 4% discount to net asset value, courtesy of Morningstar. Discounts are extended during market risk-off matches.

We see a big move during the Covid crisis and a drop in June of this year. This is one of the main differences between ETFs and CEFs. By its structure, ETFs trade equities and collateral throughout the day, while CEFs only trade equities.

When ETF shares trade at a premium to NAV, ETF dealers purchase the underlying securities of the ETF, supply them to the ETF issuer as a basket of creation, receive ETF shares in return, and reduce risk. can be sold on the market for – Free profit. These trades have the overall effect of aligning the secondary market price of the ETF with his NAV. Conversely, if the ETF’s shares are trading at a discount to its NAV, the dealer will sell his ETF’s constituents, buy his ETF’s shares on the open market, and place the ETF’s shares in the redemption basket. You can trade and finally get a risk-free profit. The ETF price is then pushed back to match the NAV, this time from below.

Conclusion

VBF is a fixed income CEF focused on US investment grade bonds. The vehicle has a structure and risk/reward metrics very similar to the much larger and better known ETF iShares iBoxx Investment Grade Corporate Bond ETF. His 3- and 5-year total returns on the two vehicles are about the same, and both are crushed by high interest rates in 2022. As an ETF, it trades at net asset value. We expect rates to stabilize heading into 2023, and we also expect his VBF discount to his NAV to shrink next year. Investment grade all-in yields are attractive now and we expect positive returns from both vehicles in 2023, with VBF outperforming.