No Free Lunch with Ultra-Short-Term Bond ETFs | ETF Trends

Ultra-short-duration bond exchange traded funds provide a suitable alternative for investors who are seeking to park their cash. However, the investments do come with some risk considerations.

These conservative bond options are attracting investors turning away from long-term bonds ahead of rising rate risks, reports Daisy Maxey for the Wall Street Journal.

Bond prices have an inverse relationship with interest rates, so rising rates corresponds with falling prices.

Investors with long-duration bonds face a deeply discounted market when attempting to sell the security before maturity since rates are more likely to rise in in the long-term. Long-term bonds have more coupon payments left before the debt matures than short-term bonds. Consequently, if the interest rate rises, the long-term bond will be underpaying investors for a longer period, which makes the old debt security less attractive to investors.

Consequently, more investors are looking into ultra-short-term bond funds with durations less than a year. According to Morningstar data, ultra-short bond funds attracted $2.5 billion over the first half of the year, after bringing in $10.7 billion and $9.5 billion in 2013 and 2012, respectively.

Once the Federal Reserve lifts rates, ultra-short funds can reinvest maturing debt at higher yields. However, investors have to be aware that prices could dip.