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.
For instance, the actively managed PIMCO Enhanced Short Maturity ETF (NYSEArca: MINT) has a 0.53% effective duration, which roughly translates to a 0.53% price decline in the event interest rates were to rise 1%. Other ultra-short-duration bond ETFs include Guggenheim Enhanced Short Duration Bond (NYSEArca: GSY), which has a 0.47% effective duration, SPDR SSgA Ultra Short Term Bond ETF (NYSEArca: ULST), which has a 0.23 year duration, and iShares Short Maturity Bond ETF(NYSEArca: NEAR), which has a 0.92 year duration.
“These are not money-market funds,” Sarah Bush, an analyst at Morningstar. ” You could see modest losses.”
Additionally, Stephen Kane, co-portfolio manager of the Metropolitan West Ultra Short Bond Fund, warns that while these types of funds may provide better income-generation than money market funds, investors are exposed to some credit risk. The ultra-short bond ETFs include slightly higher yielding corporate debt that are not as highly rated as U.S. Treasuries. MINT has a 0.49% 30-day SEC yield, GSY has a 1.05% 30-day SEC yield, ULST has a 0.30% 30-day SEC yield and NEAR has a 1.16% 30-day SEC yield.
Alternatively, investors can look at conservative short-duration Treasury bond ETFs, such as the iShares Short Treasury Bond ETF (NYSEArca: SHV), which has an effective duration 0.43 years and 0.07% 30-day SEC yield, and the SPDR Barclays 1-3 Month T-Bill (NYSEArca: BIL), which has a 0.15 year duration and a -0.09% 30-day SEC yield. [Rising Rate Preparation With Short-Term Bond ETFs]
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.