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Long/Short Investments in L/S Equity: Valuation and Ideas,

The Market’s Top IG Corporate Bond Fund – What’s In It?

The market’s best investment-grade corporate bond fund (VCLT) is released by Vanguard and contains 71 holdings, including a sub-1% cash component, at an expense ratio of 0.07% ($7 for every $10,000 invested). The fund is firmly in the investment-grade range at an A/BBB average credit rating using the Fitch and S&P scale.

The median coupon is about 5% and the maturity breakdown is predominantly in the 20-30 year range.

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The top 10 assets make up just 20% of the fund with more of an equal-weighted structure. The top 15 take up 29% and the top 50 weight out at 79%.

Though some holdings are issued by firms headquartered outside the US, it is predominantly a US-based fund. Some of the market’s top names have their credit included within it, including Verizon (VZ), Apple (AAPL), Oracle (ORCL), Berkshire Hathaway (BRK.A)(BRK.B), McDonalds (MCD), Wal-Mart (WMT), Microsoft (MSFT), IBM, and of course others.

How It Fits Into A Portfolio

I believe in the benefits of diversification. It’s impossible to know the future perfectly; therefore, exposure to a variety of different securities among various asset classes, credit qualities, and durations is important in my view to help mitigate drawdowns and better linearize returns over time.

As the correlation matrix shows below, investment-grade corporate bonds – as represented by VCLT – share a slightly negative correlation with equities. Given IG bonds are down the credit quality ladder relative to US Treasuries, the negative correlation to equities isn’t quite as strong.

Nonetheless, a simple 50/50 portfolio of US stocks and long-term corporate bonds markedly improves its risk profile.

Backtesting from 1986 forward, maximum drawdown was improved by about 40% in relative terms (29.6% versus 51.0%) while volatility is also cut down by 40%. This risk adjustment comes at the cost of just 80 basis points of annualized yield.

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Bonds have been in a bull market over these 30+ years, which has helped, but pairing together inversely correlated, cash-producing assets will be expected to improve a portfolio’s risk-adjusted returns irrespective of market direction and macroeconomic dynamics.

Complete list of holdings: