ETFs: Safe Fixed-Income Havens Amid Rising Interest Rate
U.S. fixed-income markets can be confusing, considering the steady pace of rising interest rates and an economy that is slowly chugging along. Yet, several fixed-income areas offer choices for investors to ride out some of the rate increases.
G. David MacEwen, chief investment officer and senior portfolio manager for American Century Investments, sees "a continuation of what we've seen in this kind of slow, steady-type growth, which is not overwhelming growth, but it's strong enough growth that it allows the Federal Reserve to start working on tapering their quantitative easing."
He expects interest rates to continue to creep up by the end of next year, with 10-year Treasury yields reaching above 3%, maybe near 4%.
"Most of the money that's invested in the bond market is invested in intermediate-type duration strategies ... and they have a really high capacity for interest rates to move higher," MacEwen said.
"Investors don't really have too much to worry about from that. Actually, we've shown that as investors we're better off as yields go up. ... So what we've termed the 'renormalization' of yields is over time a good thing. It's just investors have to get used to it and suffer some potentially shorter-term losses."
If you don't want to accept short-term losses in your bond portfolio, several alternatives may be a good way to go.
Shifting into shorter-term fixed-income instruments is one way of riding out the wave of rising rates. But analysts warn to stay away from high-yield and bank-loan ETFs, which carry a lot of risk. It's better to stick with higher-quality products, such as investment-grade floating-rate note ETFs.
One such ETF isMarket Vectors Investment Grade Floating Rate ETF ( FLTR ), which consists of U.S.-dollar denominated investment-grade floating-rate corporate notes. It has an SEC yield of 0.61%. Investors can earn an extra yield of about 0.25% to 0.5% over Libor and the notes reset every three months, giving it a near-zero duration.
As short-term rates rise over time, so will Libor and FLTR. Market Vectors fixed-income portfolio manager Fran Rodilosso calls FLTR "maintenance free. You're not going to experience significant capital gains if rates go higher. But if the credits themselves perform OK, you're not going to experience significant capital losses either, because from an interest-rate perspective these notes are meant to hold their value."
However, FLTR has an average daily volume of only about 31,000 shares. A more liquid fund in this universe isiShares Floating Rate Bond ( FLOT ). But its SEC yield of 0.35% is lower than FLTR's.
Another option is investment-grade corporate bond ETFs.
"You really don't want companies to have any issues with their credit as far as credit downgrades," said Tim Strauts, senior fund analyst at Morningstar. "The economy is not growing at a fantastic rate, but it's slowly chugging along. So, we're expecting credit spreads to stay with their act and maybe tighten a little bit over the next few months. So corporate bonds will do well."
He suggests taking a look atiShares iBoxx $ Investment Grade Corporate Bond ETF ( LQD ). With $18 billion in assets, it is the largest investment-grade corporate bond fund. It trades an average of 2 million shares a day and has an SEC yield of 3.52%. But its duration is 7.5 years, making it a more long-term addition to one's portfolio.