Many fixed-income ETFs have taken a hit on rising interest rates, especially funds tracking bonds with longer durations. However, many investors might not be aware of the damage in bond funds, and how much more they could lose if rates rise further.
Allan Sloan for CNNMoney pointed out that on July 5 the price of 30-year Treasury bonds declined 4.1%, or equivalent to a 615-point plunge in the Dow Jones Industrial Average with prices at 15,000.
Extended duration bond funds have weakened this year, with the benchmark 10-year Treasury yield now hovering around 2.6%. The iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) has declined 11.9% over the past three months and is down 19% from its high in July 2012. [Treasury ETFs Rebound on Bernanke, Lower Yields]
Currently, 30-year Treasuries due in November 2042 are trading about 83.9% of face value. Investors who have held on during the recent interest rate spike just witnessed six years’ worth of interest evaporate.
While the markets have been scrambling to get on the bull rally in stocks, investors have largely ignored the yearlong bear market in bonds. The 30-year Treasury yield rose to 3.65% from a 2.25% low over the past year as investors dumped bonds on speculation that the Fed would begin “tapering” its bond purchasing plan sooner than expected.
While long-term Treasuries can still decline as rates rise, Sloan points out that yields on long-term debt could stabilize or even decline as the Fed raises short-term rates to fight inflation, similar to what happened in 1995 and 2000 – high inflation eats away value on long-term bond.
Investors who want to protect against rising rates should begin shifting away from long-term debt and move into short-duration assets. Short-duration bonds are less sensitive to rising rates than long-term debt. Some options include the Vanguard Short-Term Bond (NYSEArca: BSV), Guggenheim Enhanced Short Duration Bond (NYSEArca: GSY) and PIMCO Enhanced Short Maturity (NYSEArca: MINT). [Short-Term Bond and Bank Loan ETFs for Higher Rates]
Moreover, investors can take a look at the PowerShares Senior Loan ETF (NYSEArca: BKLN). Senior loans are high-yield bonds with floating rates, which essentially removes interest-rate risk. [Bank Loan ETFs: Shelter from the Rising-Rate Storm]
For more information on the bond market, visit our bond ETFs category.
Max Chen contributed to this article.
Full disclosure: Tom Lydon’s clients own BSV.