Bonds are similar to interest-only mortgages. For example, a company may sell a bond to an individual investor for $1,000 and promise to pay 5% interest for ten years and then give the investor back the $1,000 at the end of year 10. Similar to individual mortgages, companies with stronger balance sheets and better credit history will pay a lower interest rate. The Barclay’s Aggregate Index (AGG) tracks high-quality debt (government & corporate). In contrast, the iShares iBoxx High Yield Index (HYG) tacks low-quality company debt; therefore, it pays the investor a higher dividend.
Why would one want to own high-quality bonds if low-quality bonds pay a higher dividend? First of all, in the most recent market selloff, the HYG sold off ~22% while the AGG sold off only ~5%. The panic selloff has subsided, and both funds have recovered much of their value. HYG is down approximately -4%, and AGG is up +6%. That’s still a 10% difference.
ETF of the Week: iShares Core Small Capitalized ETF (IJR)
iShares Core Small Capitalized ETF (IJR)was the best performing ETF last week at 3.8%. IJR invests in companies with a market capitalization of $600 million to $2.4 billion. Small Capitalized Stocks are known for being much more volatile than the bigger cousins S&P 500 ETF (SPY). Companies in SPY must have a market capitalization of at least $8.2 billion.