How One Strategist Uses Core Bond ETFs | ETF Trends

Ten-year Treasury yields have fallen 12% this year, sending billions of dollars into fixed income exchange trade funds. Much of that has been institutional money.

However, 10-year yields are up 3.7% in the past month and investors have pulled over $1.3 billion from the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF) in just the past week. Both are signs some investors could be preparing for interest rates to soon rise.

Boston-based ETF strategist Newfound Research, which launched earlier this year, runs a bond strategy aimed at achieving the same diversification and stock hedging exposure offered by long-dated U.S. Treasuries while mitigating interest rate risk.

“An investment universe of 12 global fixed income ETFs, with a range of credit and duration profiles is combined with six long U.S. equity ETFs and four long/short U.S. equity ETFs. A quantitative process, which is reviewed weekly, attempts to dynamically reallocate with three different ‘sleeves’ using forward volatility assumptions,” said S&P Capital IQ in a new research note.

Newfound’s Income Generation strategy seeks to achieve a 4% yield with reduced volatility, according to S&P Capital IQ.

Top holdings in that strategy include the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), the largest junk bond ETF. In late June, the average yield on junk U.S. corporates fell to a record low of 4.93% while the spread between high-yield and investment-grade corporates tumbled to its lowest level in seven years.

Some market observers believe those are signs investors are taking excessive with not enough compensation from high-yield bonds. [Bond ETFs Beloved in 2014]

Newfound’s Income Generation strategy also holds a stake in the iShares 1-3 Year Credit Bond ETF (NYSEArca: CSJ). The $11.9 billion CSJ has a 30-day SEC yield of 0.69% and an effective duration of 1.95 years. CSJ has a 0.2% expense ratio and a bid/ask spread of $0.03, notes S&P Capital IQ.

Equity positions in the strategy include the PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV). SPLV has surged 8.1% this year, a move critics of low volatility ETFs assert is attributable to the ETF’s 24.1% weight to the utilities sector, the best performer in the S&P 500 this year.