The Federal Reserve opted to leave interest rates unchanged for now, so the risk is low at this point. But as the economic recovery continues along, the risk that rates will rise is a very real one and if you’re holding bonds, you need to understand the impact that this will have.

Even after a rally going in stocks, investors are still clutching firmly to bond funds, writes Eileen Ambrose for The Baltimore Sun. Most market experts expect interest rates to start going up in the second half when the economy shows more signs of recovery, and the outcome won’t be favorable for bond holders. [How to spot and avoid ETF bubbles.]

Between January and November last year, net inflows into bonds hit $349 billion, $27 billion more than in 2008, while stocks saw outflows of $4.1 billion in the first 11 months on top of the $234 billion outflow from stocks the year before. [Bond ETFs: Good times coming to an end?]

People are still investing in bonds because of reasons like retirement, dramatizing effect of 2008 on investors and the higher yields offered as compared to money market funds. John Rekenthaler, vice president of research at Morningstar, says that high-quality bond funds such as long-term U.S. Treasuries will be most vulnerable when rates go up. High-yield funds we be least affected if rates rise in an improving economy because it is believed that companies are less likely to default in a healthy economy. [It's time to look at bonds differently.]

• iShares Barclays 7-10 Year Treasury Fund (NYSEArca: IEI)
• iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG)
• SPDR Barclays Capital High Yield Junk (NYSEArca:JNK)

Portfolios still need some bonds for stability in the long-term. Investors may want to rearrange their holdings and stick to bonds with short-term maturities. Rekenthaler also suggests investing in funds with foreign bonds because “other countries’ interest rates might not rise and sink with ours.” Investors may also consider dividend-paying stocks or municipals as alternatives.

• iShares Barclays 1-3 Year Treasury Bond (NYSEArca: SHY)
• PIMCO 1-3 Year U.S. Treasury Index Fund (NYSEArca: TUZ)
  
• SPDR Barclay International Treasury Bond Fund (NYSEArca: BWX)
• SPDR Barclays Short Term International Treasury Fund (NYSEArca: BWZ)
• iShares S&P National Municipal Bond (NYSEArca: MUB)
• PIMCO Enhanced Short Maturity Strategy Fund (NYSEArca: MINT)
• Market Vectors Short Municipal (NYSEArca: SMB)
  
• SPDR Barclays Capital Short-Term Muni Bond (NYSEArca: SHM)

It is easy to get caught inside of a bubble and then miss warning signs that are telling you to get out. This is why we have an 8% stop loss – once a fund declines 8% off the recent high or dips below its 200-day moving average, we get out. Having a strategy with a stop-loss can help put a limit on your overall losses. [ETF trend following strategy.]

For more information about ETF strategies, check out The ETF Trend Following Playbook.

For more information on trend following, visit our trend following category.

Max Chen contributed to this article.

A bond is a loan that a bond purchaser makes to a company, as stated in American Chronicle. Thomas E. Murphy, certified financial planner at TEMAA Financial, says bonds serve to reduce volatility in a portfolio while generating income – the quarterly, semi-annual or annual fixed income is generally more than dividend payments from stocks. [iShares launches muni bond funds.]

Bonds have an inverse relationship with market interest rates – the price of a bond falls as interest rates rise. Bond investors may use a strategy called “laddering” to decrease interest rate risk by buying bonds of various maturities. As a bond matures, you may reinvest in higher-yielding bonds if rates rise. [What to watch as yields rise.]

One option for diversifying your bond holdings is by buying ETFs, which give exposure to hundreds or even thousands of bonds in one single transaction. However, it’s important to approach your bond portfolio as you would your equity portfolio and to be prepared to adjust as conditions change. [Why it's time to approach bonds differently.]

The decline in inflation, which is practically at zero, and the sharp decline in market interest rates may be indicators of a reversal of fortune for the Treasury bond market, writes Paul J. Lim for CNN Money. Peng Chen, president of the investment consulting firm Ibbotson Associates, believes a bear market in Treasuries may occur if inflation rises and the Fed has to raise interest rates.

Here are three strategies for the fixed-income investor:

• Don’t want to incur loses? There is virtually no credit risk if you stick to U.S. Treasuries since the government won’t default on the loan. But rates may rise and reduce your bonds’ value in the open market.  Among your options: Reduce risk by keeping to short-term exposure, which reduces vulnerability to price swings; keep a portion of Treasuries in individual issues and ladder your securities; and/or put some money away into Treasury inflation-protected securities (TIPs). [What to watch as bond yield rises.]
• More risk-tolerant? Consider taking on sovereign debt of other countries. Foreign debt also has the added benefit of a exchange rates, especially if the U.S. dollar is weakening. An easy way to access international Treasuries is through ETFs. [Diversify with international bonds.]
• Not too risky, but not too safe? Try adding some municipal or corporate bonds into the mix. It should be noted that munis are also free from federal tax and, in some cases, state and local taxes. Corporate bonds also help reduce a portfolio’s potential exposure to losses.

For more information on bonds, visit our bond category.

• iShares Barclays Aggregate Bond Fund (NYSEArca: AGG)
• Vanguard Total Bond Market (NYSEArca: BND)
• iShares Barclays 7-10 Year Treasury Fund (NYSEArca: IEI)
• SPDR Barclays Capital High Yield Junk (NYSEArca:JNK)
• iShares iBoxx $ High Yield Corporate Bond (NYSEArca: HYG)
• SPDR Barclays Capital Short-Term Corporate Bond (NYSEArca: SCPB)
• SPDR Barclay International Treasury Bond Fund (NYSEArca: BWX)
• SPDR Barclays Short Term International Treasury Fund (NYSEArca: BWZ)
• iShares Barclays TIPs Bond ETF (NYSEArca: TIP)
• SPDR Barclays Capital TIPS (NYSEArca: IPE)
• PIMCO 1-5 Year U.S. TIPS (NYSEArca: STPZ)
• iShares S&P National Municipal Bond (NYSEArca: MUB)
• SPDR Barclays Capital Short-Term Muni Bond (NYSEArca: SHM)

Max Chen contributed to this article.

Jim Ross, president and senior managing director at State Street Global Advisors cautions, “Now is not the time to just buy some bonds and forget about it.” That approach could get you burned.

Ross instead urges investors to take a more active role in their fixed-income portfolio, especially as the threat of rising interest rates looms. That makes it more important than ever for investors to look at the bonds they hold and ensure that they’re diversified across the yield curve. It’s important to be nimble and reactive as interest rates rise and fall. [What the yield curve means for ETFs.]

As rates change, it affects bond exchange traded funds (ETFs) in different ways. A long-term bond fund will take a greater hit to its value when interest rates rise than a short-term bond fund. When interest rates fall, the reverse is true.

Just as you would take a diversified approach to the equity side of your portfolio – perhaps some allocation to emerging markets, some more to domestic stocks and so on – Ross urges investors to think of their fixed-income portfolio in the same way.

“If you look at where the inflows have been, it’s mostly core [bond] funds. Investors just go get the broadest thing out there,” Ross says. The trouble with that? “You’re taking on the risk of potential rate hikes.” [High-yield ETFs: Is the party over?]

You could also potentially be ignoring the bigger picture. When it comes to equities, investors often buy based on what they think will happen: small-cap may outperform large, or domestic stocks might outperform global ones.

“People need to look at bonds the same way.” Ross says. If you’re investing in a particular bond type because you have a specific view of the market, a broad fund won’t give you much of the exposure you’re seeking. [Benefits of international bonds.]

Ross is heartened by the increased allocation to fixed-income in many portfolios, up from 40% closer to 60%. But if bond funds represent that much of a chunk, he says, investors need to carefully consider what they should be buying.

If your view is that the U.S. dollar will continue to weaken, international Treasuries and both U.S. and non-U.S. Treasury Inflation-Protected Securities (TIPS) “make complete sense,” says Ross. [TIPS: Your questions answered.]

In the event of stagflation – little to no growth coupled with inflation – investors may head to the short end of the yield curve.

“The old buy-and-hold approach on the equity side didn’t necessarily work out in the last 10 years. Buy and hold on the fixed-income side may not necessarily help, either.”

Ross doesn’t feel this way simply because we’re in a low-rate environment, either. Taking a more active role in your fixed-income portfolio should be a long-term shift, he says. “You could make the case that it should have been there five years ago.” [How to research bond ETFs.]

The best yields right now, says Ross, are those coming from high-yield bond funds, such as the SPDR Barclays Capital High Yield Bond (NYSEArca: JNK), which is yielding 12%. iShares iBoxx $ High Yield Corporate Bond Fund (NYSEArca: HYG) is yielding 9.8%.

In a recent appearance on CNBC, Ross’s pick for the current environment is the SPDR Barclays Capital Short-Term Corporate Bond (NYSEArca: SCPB), which launched last month. It tracks the 1-3 year U.S. investment-grade corporate bond market.

Don’t be afraid to look abroad, either, says Ross. In fact, his feeling is that U.S. investors are under-allocated to international bonds for the same reasons they’re under-allocated in international equities. “Anytime you go outside the U.S., there’s more perceived risk.”

But international yields right now are a little better than those in the United States, meaning that they may be an opportunity for a yield pickup. An additional benefit of international fixed-income investing is that it’s a dollar play, as well. “If the dollar strengthens, you lose,” says Ross.

International fixed-income plays include the SPDR Barclays Capital International Treasury Bond (NYSEArca: BWX) and the SPDR DB International Government Inflation-Protected Bond (NYSEArca: WIP).

It was a down year for the U.S. dollar. As economic conditions shift, investors are putting the currency under the microscope in an effort to determine what’s next. Ben Levisohn for BusinessWeek believes that in 2010 the dollar will be center stage again—only this time it will be a highly volatile greenback that challenges investors.

The most recent roller coaster ride was a small dose of what may be on tap for next year. In just a few days, the Dubai World fiasco and the Greek sovereign debt downgrade drove investors to seek refuge in the recently scorned dollar. U.S. treasuries were snapped up, the euro slumped, and the dollar rose 2.5%.

Besides dollar-focused ETFs, there are other ways to play the movements in the U.S. dollar. Sam Subramanian for Seeking Alpha gives some alternatives:

• Gold: The classic hedge to the U.S. dollar, gold is experiencing record highs and lots of attention. SPDR Gold Shares (NYSEArca: GLD) has profited from the spike in interest and the haven-like quality of the metal. However, gold’s upside potential can be limited if the U. S. economy cooperates and renders the Fed’s job easier. If short-term rates are going to increase, even a relatively large hike in fed funds, say 1%, would still keep rates within Chairman Ben Bernanke’s “exceptionally low levels,” explains ETF Desk forSeeking Alpha.
• International Bond Funds: International bonds offer foreign currency exposure, geographic diversification, current income and potential for capital gains. Generally, individual investors are not equipped to analyze individual international bonds, so seeking an advisor’s help may be necessary. Check out SPDR Barclays Interntational Treasury Bond (NYSEArca:BWX).
• International Stocks and Funds: One can profit from a decline in the  U.S. dollar by investing a portion of the portfolio in well-managed, natural resource economies such as Australia and Canada. Natural resources like oil and base metals are priced in U. S. dollars and often rise in price when the dollar declines. iShares MSCI Australia (NYSEArca: EWA) and iShares MSCI Canada (NYSEArca: EWC).

Direct ways to play the U.S. dollar:

• PowerShares U.S. Dollar Bullish (NYSEArca: UUP)
  
• PowerShares U.S. Dollar Bearish (NYSEArca: UDN)

For more stories about currency ETFs, visit our currency ETF category.

International bond ETFs help diversify a portfolio and provide exposure to non-U.S. Government Treasury bonds by tracking indexes with a set maturity taken from the average of the various bond maturity dates, as stated by Seeking Alpha. International bond ETF distributions are not exempt from state and local taxes. Investors should also note that emerging market bond ETFs are riskier than developed market bond ETFs, but the risk comes with higher yields. (Diversify with International bond ETFs).

• SPDR Barclays Capital International Treasury Bond ETF (NYSEArca: BWX): up 9.6% year-to-date; yield is 1%; expense ratio is 0.5%; holds some emerging market bonds.
• iShares S&P/Citi International Treasury Bond ETF (NYSEArca: IGOV): up 3.4% in the last three months; expense ratio is 0.35%
• iShares JPMorgan USD Emerging Markets Bond ETF (NYSEArca: EMB): up 15.3% year-to-date; yield is 5.7%; expense ratio is 0.6%
• PowerShares Emerging Markets Sovereign Debt Fund (NYSEArca: PCY): up 36.1% year-to-date; yield is 6.29%; expense ratio is 0.5%

In general, bonds are considered safer than stocks; however, bonds generate lower long-term returns compared to stocks. The price of bond ETFs is inversely related to projected interest rates.

International TIPS, or Treasury Inflation-Protected Securities, pay interest equal to the country’s consumer price index along with a premium. This bond type tends to outperform normal bonds when inflation is projected to rise but underperforms during times of deflation.

• SPDR DB International Government Inflation-Protected Bond ETF (NYSEArca: WIP): up 20.6% year-to-date; 1% yield; expense ratio is 0.5%

Bond investors may also invest in short-term International bond ETFs, which can be used as an alternative to money market funds. Short-term bond ETFs pay lower yields than their long-term counterparts, with the exception of periods of an inverted yield curve – a widely held indicator of a pending recession.

• SPDR Barclays Cap Short-Term International Treasury Bond ETF (NYSEArca: BWZ): up 3.8% in the last three months; expense ratio is 0.35%
• iShares S&P/Citi 1-3 Year International Treasury Bond ETF (NYSEArca: ISHG): up 3.2% in the last three months; expense ratio is 0.35%

For more information on international bonds, visit our international Treasury bonds category.

Max Chen contributed to this article.

Last week, a solid majority of fund types reported their best weekly inflows of the year while money market funds experienced large outflows, writes Joe Morris for Ignites.

EPFR Global data shows where all the money has moved: $1.62 billion went into global bond funds, $540 million found its way into emerging-market bond funds, $925 million funneled into the real estate sector, $1.74 billion flowed into global equity funds, and money funds lost $47.2 billion.

Some ETFs representing these areas include:

• SPDR Barclays International Treasury Bond Fund (NYSEArca: BWX): up 6.6% year-to-date

• PowerShares Emerging Mkts Sovereign Debt (NYSEArca: PCY): up 37.7% year-to-date

• iShares Dow Jones U.S. Home Construction (NYSEArca: ITB): up 37.2% year-to-date

• SPDR S&P World ex-US (NYSEArca: GWL): up 25.9% year-to-date

• WisdomTree U.S. Current Income Fund (NYSEArca: USY): up 2.1% year-to-date

Commodity sector funds also added $1 billion last week, accumulating more than $9 billion in year-to-date inflows.

• iShares S&P GSCI Commodity Indexed Trust (NYSEArca: GSG): up 2.8% year-to-date

Investors are becoming more confident, but many still remain cautious about the market. U.S. bond funds have seen net inflows every week this year and recently saw an increase by $2.79 billion. Global bond funds have seen inflows for 23 straight weeks.

• iShares Lehman 7-10 Year Treasury Bond Fund ETF (NYSEArca: IEF): down 5.4% year-to-date

Value funds are outperforming growth funds for the first time since late August. U.S. stock funds received $340 million, mid-cap ETFs, U.S. sector funds and actively managed big-cap growth funds all raked in new money as big-cap blend ETFs saw outflows.

• Vanguard Total Stock Market (NYSEArca: VTI): up 22.8% year-to-date

• Vanguard Large-Cap ETF (NYSEArca: VV): up 20.8% year-to-date

Max Chen contributed to this article.

A prudent way to hedge against the devaluation of the U.S. dollar is through the bond ETF SPDR Barclay International Treasury Bond Fund (NYSEArca: BWX), remarks Gary Gordan for ETF Expert. BWX is showing an income stream of 2.25% with a 0.6% premium to net asset value (NAV) and a average maturity rate of 8 years. It’s up 4.7% year-to-date.

An alternative foreign bond ETF to consider is the SPDR Barclays Short Term International Treasury Fund (NYSEArca: BWZ). Though it has a 30-day SEC yield of 1.15%, BWZ has a faster average maturity of 1.7 years. The result is less risk with an investment that is a currency hedge on top of a low correlation for diversification. It’s up 3.1% in the last three months.

Investors also have to consider foreign inflationary trends, especially when world economies are throwing money around willy-nilly and pushing interest rates to epic lows. That’s when SPDR DB International Government Inflation-Protected Bond Fund (NYSEArca: WIP) may become useful. WIP has an average maturity of 12 years with a SEC yield of 1.75%. It’s up 13.5% year-to-date.

Finally, an investor may want to take a gander at Nuveen Multi-Currency Short-Term Government Income Fund (NYSE: JGT), which provides income through direct and indirect investment in short-term international government securities. JGT is trading close to a 7% discount to its NAV and it has an annual distribution of almost 9% on quarterly payments. It’s up 22.7% year-to-date.

For more information on foreign bonds, visit our international Treasury bonds category.

Max Chen contributed to this article.

Many ETFs have been trending higher in recent weeks, says Gary Gordon for ETF Expert. The pattern of the funds recovering indicates that while investors are more willing to take on risk than they were a year ago, there is still some fear lingering.

The stimulus package is proving to lead to increasing business access to credit and government-stimulated GDP.

Some of the ETFs that have been on the move by varying degrees in the last month or so include:

• iShares Investment Grade Bond (LQD)
• iShares High Yield Junk (JNK)
• SPDR International Treasury Bond (BWX)
• JP Morgan Emerging Market Bond (EMB)
• iShares S&P Preferred Index (PFF)
• iShares Lehman Treasury 20-Year Treasury Bond (TLT)
• Vanguard Total U.S. Market (VTI)
• Vanguard Developed Europe Pacific (VEA)
• Vanguard MSCI Emerging Markets (VWO)

TLT’s presence on the list is evidence that there’s still some worry hanging around. Treasury debt prices rose on Wednesday, in fact, as investors wondered whether the recovery had staying power, reports  John Parry for Reuters. Investors also don’t seem to be up for taking on much risk via commodities, Gordon points out.

There will still be market pullbacks and corrections as well as profit-taking, but pick your spots. There are several areas that are in uptrends – you just have to look for them. At ETF Trends, we use the 200-day-moving-average to spot market trends and patterns.

For more stories about trend following, visit our trend following category.

Meanwhile, forecasts for Belgium’s economy are claiming a 4% decline this year, according to the Organization for Economic Cooperation and Development. The projections are more pessimistic than the actual country’s are – Belgium sees a contraction next year of 0.5%, says Philip Blenkinsop for Reuters.

Belgium has a heavy dependence on world trade; exports make up more than two-thirds of the country’s gross national product. Countries that rely on trade have been hit especially hard in the recession.

About $26.6 billion has been sold off as European bonds declined, sending the German bond, Europe’s benchmark security, up from a one-month low as a report showed Europe’s manufacturing and service industries shrank in June at the slowest pace in nine months. Despite this, governments are still issuing lots of debt and high price levels are still evident, reports Anna Rascouet for Bloomberg.

Germany will not be turning to investment banks to sell their regular debt this year. Belgium is continuing to issue notes, as their system is “winning” and everyone wants to buy German bonds. German bonds returned 0.6 % this month, compared with a 1% loss for U.S. debt, according to Merrill Lynch.

• iShares MSCI Belgium Index (EWK): up 17.1% year-to-date

• SPDR Barclays Capital International Treasury Bonds (BWX): up 0.3% year-to-date; Belgium is 4.6% of assets

For more stories on Belgium, visit our Belgium category.

Diversification is one way to reduce risk while optimizing overall returns, and finding non-correlating assets is key to diversification, remarks Gary Gordon for ETF Expert. By reducing risk, an investor should consider a mix of low-correlating assets and some developed market funds.

Most developed markets indexes move in unison with another. Some examples include:

• S&P 500 SPDR Trust (SPY): up 5.9% year-to-date
• iShares S&P Small Cap 600 (IJT): up 7.8% year-to-date
• iShares Global 100 (IOO): up 4.6% year-to-date
• Japan’s iShares MSCI Tokusai Index (TOK): up 9.9% year-to-date

Foreign fixed income, natural resource, commodity, energy, emerging market, currency, and precious metal stocks all had smaller correlations to broad market developed stock funds. Related ETFs include:

• SPDR Lehman International Treasury Bond ETF (BWX): up 1% year-to-date
• iShares Natural Resources Fund (IGE): up 23.9% year-to-date
• iShares Dow Jones-AIG Commodity Index ETN (DJP): up 11% year-to-date
• Alerian MLP ETN (BSR): up 26.2% year-to-date
• iShares Emerging Market Fund (EEM): up 36.7% year-to-date
• Powershares Precious Metals (DBP): up 16.1% year-to-date

Finding non-correlating assets is just one piece of the overall puzzle.When looking into the broad market or specific sectors, a savvy investor should have a strategy in place. Take a look at our investing strategy to get a sense of things.

Max Chen contributed to this article.