Hedge Against Market Turns with Short-Term Bond ETFs

March 26th at 7:30am by Tom Lydon

Investors have used fixed-income assets and bond exchange traded funds to help cushion the shocks in the riskier equities market. However, as we look to a longer time horizon, the diversification effects of bonds begin to diminish.

Bonds may be offering lower long-term protection from stocks than what many have come to believe, writes Mark Hulbert for Barron’s.

Since 1970, the correlation coefficient between annual returns of the S&P 500 index and long-term Treasuries was 0.02- a 1.0 reading would indicate perfect correlation and a zero means no correlation. However, looking at five-year returns, the correlation coefficient rises to 0.36, and over 10-year periods, the coefficient rises to 0.67.

Between January 1966 and November 1982, the Dow Jones Industrial Average remained flat in nominal terms, but in inflation-adjusted terms, the Dow lost more than two-thirds of its purchasing power. Meanwhile, bonds were pummeled as long-term rates jumped to almost 15% from below 5%.

Nevertheless, investors should still hold some bond allocations to help level off volatility in the equities market but look toward cash and short-term bonds instead, according to James Stack, editor of the InvesTech Research.

While the yields may be less than ideal, the short-term debt and cash will help cushion the blow during a market decline.

For instance, Stack points to the Vanguard Short-Term Investment Grade bond fund. Investors can also take a look at the ETF version of the fund, the Vanguard Short-Term Bond ETF (NYSEArca: BSV). BSV has an average duration of 2.7 years and a 0.79% 30-day SEC yield.

Additionally, instead of holding on to cash in a deposit account, investors can consider ultra-short-duration bond ETFs as a cash alternative. The actively managed PIMCO Enhanced Short Maturity ETF (NYSEArca: MINT) and Guggenheim Enhanced Short Duration Bond (NYSEArca: GSY) can both be used as a money market alternative. [Ultra-Short-Term Bond ETFs as Cash Alternatives]

MINT includes emerging market and developed market government, corporate, mortgage-related short-term investment-grade debt. The PIMCO ETF has a 0.69 year duration and comes with a 0.55% 30-day SEC yield. GSY also includes international government and corporate debt, and it can hold up to 10% of its assets in high-yield, junk debt. The Guggenheim ETF has a 0.33 year duration, 0.28% expense ratio and a 0.96% 30-day SEC yield.

PIMCO Enhanced Short Maturity ETF

For more information on bonds, 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. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. 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.