IUSB Has Minimal Credit Risk, But Duration Is A Problem (NASDAQ:IUSB)

The iShares Core Total USD Bond Market ETF (NASDAQ:IUSB) is one of those bond ETFs that the concerned investor might be considering right now to defend against the oncoming recession. Employment is on stilts while consumer confidence collapses. Economic conditions invite further rate increases, and the state of the economy could worsen a lot. High credit ratings are a safety, but watch out for duration in fixed income instruments, IUSB has a fair bit of it.

IUSB Breakdown

From a credit quality perspective, we trust the heavy skew towards AAA. The credit risk is nonexistent.

From a maturity perspective there are a lot of bonds that have 7-10 year durations within the portfolio.

Naturally, coupons help with bringing down the effective duration which average on a weighted basis at around 4.9 years according to the detailed holdings.

The current YTD declines in the ETF is around 10% implying that with 4.9x sensitivity to rate hikes puts the implied rate hike YTD at 2%, which is consistent with the announcements the Fed has made at its meetings: two 75 bps hike plus a little bit more from the beginning of the year.

Economics

The Fed has already made clear its stance on inflation, which is that it will not tolerate it. With unemployment still very low and inflation still high, the economy is inviting further rate hikes. The reason partly for the continued employment and inflation is corporate optimism. Consumers have actually gotten the memo on the economy. They’re spending much less, at least off the pandemic highs, but corporates continue to hire. If recent employment is on weak stilts, then we might get rate hikes on top of already peaking employment on the basis of rate levels from a month or two ago. This makes it more likely for the Fed to reverse course, which would actually be good for IUSB investors, but regardless rates are coming up, and we feel that a 10% YTD decline is too little considering the duration of the portfolio. The ETF should have been more sensitive to the current increases.

From a yield perspective, the average coupon in this ETF isn’t that good either at 2%. While the fees are low at 0.07%, they do eat at that yield a little. The YTM is around 3.2%, but then again it doesn’t do many favors for the ETF. With reference rates quickly climbing even past 3% on short term treasuries, which don’t have that duration risk, the 3.2% with duration risk is not attractive. While over time the effective maturity will decline, there is still the loss of economic value by having reaped a weaker yield than you could have. Overall, duration risk makes this not very interesting. We don’t know if we’re coming to a new baseline level of rates. Don’t bet on a reversion here, and certainly realize that rates are very likely to rise a little longer at least.

While we don’t often do macroeconomic opinions, we do occasionally on our marketplace service here on Seeking Alpha, The Value Lab. We focus on long-only value ideas, where we try to find international mispriced equities and target a portfolio yield of about 4%. We’ve done really well for ourselves over the last 5 years, but it took getting our hands dirty in international markets. If you are a value-investor, serious about protecting your wealth, us at the Value Lab might be of inspiration. Give our no-strings-attached free trial a try to see if it’s for you.