With 2016 drawing to a close, investors are apprehensive about whether bond ETFs can maintain or flounder their momentum in 2017. The surprise win of Donald Trump as the next U.S. President has resulted in massive sell-off of bonds. While global equities saw increased inflow post Trump's win, the bond market tanked wiping out more than trillion of dollars. This represents the biggest sell-off since the "taper tantrum" in the summer of 2013. (read: Trump Win Sparks Sell-Off in Bonds: Short with These ETFs )
Despite this, the ETFs tracking global debt markets have been witnessing a record breaking inflow this year. According to BlackRock , assets in ETFs tracking bond indices reached $594 billion worldwide by November 2016, marking a ten-fold increase since 2007. So far this year, equity ETF sales totaled $186 billion while bond ETFs have attracted a record $109 billion of inflows, though it represents only a fifth of the global ETF market by assets.
Rising interest rates can pose a challenge for bond investors. The Fed recently raised interest rate by 25 basis points and has hinted that it may hike interest rate as much as three times in 2017. Generally, when interest rate rises, bond prices fall, provided other macro-economic variables remain constraints. Therefore, investment in bond ETFs may become a risky proposition.
However, we believe not all bond ETFs behave the same way. Bond ETFs are professionally managed, diversified baskets of bonds with varying maturity dates and yields. Unlike individual bonds, bond funds typically don't have a set maturity date because the managers often buy and sell bonds before they mature, and thus these funds are not under any obligation to return the principal amount.
The bond market is likely to take center-stage in 2017, and may prove to be the primary driver for markets. Several industry watchers are reasonably bullish about the performance of bond ETFs in 2017. Rick Rieder, BlackRock's chief investment officer of global fixed income , noted that investors can earn decent returns from shorter-term debt, such as bank loans, high-yield bonds, asset-backed securities, and some emerging-market bonds. John Bellows, a portfolio manager at Western Asset , believes that the interest rate hikes will not be in close succession in 2017. After the rapid run-up in rates, he says, it's likely that the benchmark 10-year rate will decline early next year.
Bonds be a good option which offers the positives of fixed-income security and a hedge against more risky equity investments. Specifically, the investment grade corporate bonds can offer significantly higher yield without any significant risk. Notably, investment grade bonds focus on companies with excellent credit ratings and a very low risk of default. Moreover, as the Fed is expected to hike rates faster in the future, yields in safer U.S. government bonds will also be higher. (read: Will Muni Bond ETFs Bleed Under Trump or be Contrarian Bets? )
Furthermore, the interest-hedged high yield bond ETFs may also become a powerful tool for investors who are anxious about rising interest rates. These types of funds which look to track high yield bonds and has an interest rate hedge built into its strategy, could become a safer bond and yield play in the high interest rate scenario. (read: Interest-Hedged High Yield Bond ETF (HYHG) Hits New 52-Week High )
ETFs in Focus
Below we highlight a few bond ETFs which we believe will perform reasonably well in the days ahead:
VanEck Vectors Fallen Angel High Yield Bond ETF ( ANGL ): This fund replicates as closely as possible, before fees and expenses, the price and yield performance of BofA Merrill Lynch US Fallen Angel High Yield Index. The ETF manages assets worth $477.30 million and an average daily trading volume of 234,371 shares. The fund charges an expense ratio of 40 basis points a year. ANGL gained a substantial 25.66% year-to-date (as of December 22, 2016).
PowerShares Fundamental High Yield Corporate Bond Portfolio ETF ( PHB ): This ETF is based on the RAFI High Yield Bond Index. It invests at least 80% of its total assets in securities comprising the Index which is comprised of US dollar-denominated bonds registered for sale in the US. Only securities with greater than 1 year to maturity qualify for inclusion in the Index. The fund manages an asset size of over $1,128.90 million and an average daily trading volume of 801.967 shares. The fund charges an expense ratio of 50 basis points a year. PHB gained 12.48% year-to-date (as of December 22, 2016).
SPDR Barclays Capital High Yield Bond ETF ( JNK) : This ETF seeks to provide investment results that, before fees and expenses, correspond generally to the price and yield performance of the Barclays High Yield Very Liquid Index. The fund manages an asset size of over $11,753.60 million and an average daily trading volume of 12,015,733 shares. The fund charges an expense ratio of 40 basis points a year. JNK gained 11.26% year-to-date (as of December 22, 2016).
iShares iBoxx $ High Yield Corporate Bond ETF ( HYG ): This fund seeks investment results that correspond generally to the price and yield performance of Markit IBOXX USD LIQUID HIGH YIELD INDEX. The ETF manages assets worth $18,231.60 million and an average daily trading volume of 13,046,852 shares. The fund charges an expense ratio of 50basis points a year. HYG gained 9.75% year-to-date (as of December 22, 2016).
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.