Vanguard Short-Term Corporate Bond ETF Is A Better Choice Than U.S. Treasuries (NASDAQ:VCSH) (2024)

ETF Overview

Vanguard Short-Term Corporate Bond ETF (NASDAQ:VCSH) focuses on short-term investment grade corporate bonds in the United States. The ETF tracks the Bloomberg Barclays U.S. Corporate Bond 1-5 Year Index. VCSH has low credit risk as all of the bonds in its portfolio are investment grade corporate bonds. It also has very low interest rate risk due to its short average effective maturity year of 3.1 years. Given that the Federal Reserve is already buying investment corporate bonds and that the low interest rate environment will persist at least until 2022, we think VCSH’s bond value is well supported. Hence, this is a good fund for investors seeking higher fixed income than U.S. treasuries as it offers an average yield to maturity of about 1.5%.

Fund Analysis

Low credit and low interest rate risks

We typically evaluate two scenarios of bond ETFs. For investors of bond ETF, it is important to evaluate whether these funds are vulnerable to credit rating downgrades and change in interest rate. We will first take a look at VCSH’s credit risk. As can be seen from the table below, all of VCSH’s bonds are investment grade bonds. For reader’s information, bonds with credit ratings of Baa or above are considered investment grade bonds. These bonds are much less risky than non-investment grade bonds as investment grade bonds’ default rate is only about 0.10% per year (based on 32-year period measured). On the other hand, default rate for below-investment-grade bonds was 4.22% per year. Therefore, we think VCSH has little credit risk.

Source: Vanguard Website

Next, we will evaluate VCSH’s interest rate risk. A bond fund’s interest rate risk is evaluated by looking at its average effective maturity year. In general, short-term bonds are less impacted by the changes in interest rate as these bonds only have several years before reaching maturity. On the other hand, long-term bonds’ market value can be significantly impacted by the change of interest rate. As can be seen from the table below, nearly all of VCSH’s bonds have effective maturity years less than 5 years. In fact, VCSH’s average effective maturity year is only 3.1 years.

Source: Vanguard Website

The short average effective maturity year of VCSH’s bonds means that its fund price will be less impacted by the change of interest rates. As can be seen from the chart below, its fund price only changed by 7.4% in the past 10 years despite the 78.3% decline in 10-year treasury rate.

The current macroeconomic environment is favorable

Now that we have discussed about VCSH’s interest and credit risks, we will take a look at the current macroeconomic environment. We believe the current environment is favorable to VCSH investors for several reasons:

First, the Federal Reserve is expected to support the corporate bond market by buying quality corporate bonds. Investors may recall that back in April, the Federal Reserve announced that they will be purchasing corporate bonds downgraded from investment-grade ratings as of March 22 or later that are now rated at least BB-/Ba3. In fact, the Federal Reserve has started buying individual corporate bonds on June 15. The Federal Reserve’s action has restored investor confidence and should support the value of many investment grade corporate bonds. We expect VCSH’s portfolio of investment-grade bonds to benefit from this.

Second, the current low interest rate environment is expected to persist for a lengthy period of time. In fact, the Federal Reserve’s Chairman Jerome Powell has recently stated that there will not be any rate increases through 2022 and that bond/treasury purchases will continue as planned. This means that interest rates and bond yields will likely remain low through 2022. Although VCSH’s bond price is not very sensitive to the change of interest rate (due to its short-term average maturity year), a low rate environment reduces the downside risk of owning VCSH further. Therefore, we think the environment is favorable for VCSH.

Other Risks

Most of VCSH’s bonds are issued by companies in the industrial and finance sectors (see table below). These two sectors are cyclical sectors. Therefore, a prolonged recession may have greater impact on these companies that issued these bonds than other companies. Fortunately, the finance sector is in a much better shape heading into the COVID-19 crisis than back in the Great Recession. Therefore, the impact of COVID-19 on finance sector may not be as severe as many would have thought.

Source: Vanguard Website

Investor Takeaway

If your goal is to receive a stable dividend income, VCSH is a choice to consider. The bond fund provides investors with an average yield to maturity of 1.5%. This is not high, but better than short-term U.S. treasuries. For example, VCSH’s peer Vanguard Short-Term Treasury ETF (VGSH) provides an average yield to maturity of only 0.2%. Therefore, VCSH is a good investment vehicle for investors seeking higher interest income than other funds that focuses solely on U.S. treasuries.

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