Bond ETFs

Bond ETFs led all asset classes in terms of inflows this year but there are worries investors who have piled into fixed-income funds could get hurt if interest rates finally start rising in 2013.

Taxable bond ETFs listed in the U.S. gathered $48 billion year to date through November to lead the major categories, according to Morningstar.

Bond exchange traded funds have experienced phenomenal growth over the past few years in the wake of the financial crisis with investors putting a premium on safety.

“The bull market for fixed income is over 30 years old, and the current crop of investors may be in for a rude awakening when it finally turns sour,” writes Spencer Jakab for the Wall Street Journal. “There have been bond bear markets before, of course—notably in the 1970s when bonds were dubbed certificates of confiscation—but a drop in values may be much more alarming and easier to act upon today for bond investors who generally own them through mutual or exchange-traded funds.”

Since 2007, bond mutual funds saw their assets swell by $1.7 billion, or 101%, while stock mutual funds have lost $715 billion, or 11%, of their assets under management, Jakab notes. [Navigating 2012’s Twists With Fixed Income ETFs]

However, with the Federal Reserve keeping a lid on interest rates, and Treasury bond yields hovering around historical lows, investors are faced with potential interest rate risks.

Specifically, the current low coupon rates would increase loses if interest rates return to normal. Jakab calculates that a recently issued 10-year Treasury note would depreciate 29% if rates returned to 6% while a 30-year Treasury bond would lose 57%.