How Changes in Bond Rates Affect Fixed-Income ETFs

March 30th at 12:00pm by Tom Lydon

Slowly but surely, interest rates are moving higher after hitting historic lows last year during the height of market volatility. Now, more exchange traded fund investors are wondering how the change will affect their fixed-income portfolios.

At the start of March, yields on 10-year Treasuries were hovering around 2%, but positive data, including an improving U.S. economy, debt exchange in Greece and increased investor optimism, has diminished the demand for safe-haven Treasuries, which raised interest rates in the process, writes Matt Tucker, CFA, Managing Director at iShares. Yields on 10-year Treasury notes are currently at around 2.18%.

“This is a fairly meaningful move over a short period, and it prompted many of our clients to reach out to us with questions about what rising interest rates might mean for their fixed income ETF holdings,” Tucker said.

If interest rates rise, traditional bond holders would either hold onto a security until maturity or sell now at a loss.

In comparison, most fixed-income ETFs do not mature. ETFs have a “maturity range” that they target, or follow a specific basket of bond maturities and rebalance their portfolios as bond holdings mature to achieve their time mandate. [Afraid of Rising Rates? — Consider These Bond ETFs]

Consequently, fixed-income ETFs usually adjust to the current yield environment. Bond ETFs have an innate bond laddering strategy built within the funds. The fund, like individual investors, would hold securities with differing maturity dates, and when the bonds mature, it uses the returns to reinvest at current rates.

“Whether you choose an individual bond or a fixed income ETF, your investment will be impacted by rate changes,” Tucker added. “Understanding that impact is an important step in deciding which vehicle is right for you.”

For more information on bond funds, visit our bond ETFs category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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