Bond ETFs for Income Generation While Hedging Rate Risks

After a three-decade rally in the fixed-income market, bond investors will likely have to contend with a rising rate environment ahead. Nevertheless, people can utilize exchange traded funds that leverage institutional approaches to manage their risk exposure.

“While we don’t anticipate that rates will soar, we are concerned over the long term of the vulnerability of bond returns to a moderate rise in rates,” Rick Harper, WisdomTree’s Head of Fixed Income & Currency, said on the recent webcast, Fixed Income Strategies at Taper’s End – Are You Really Prepared?

Investors are may be overexposed to interest rate risk. Ideally, fixed-income investors should have a balanced duration and yield exposure. However, due to the low rate environment, investors have been forced into longer durations to generate more attractive yields. Consequently, a small bump in interest rates could wipe out a large chunk of income gains.

“Relative to historical periods, U.S. bonds are offering limited coupon cushion with greater sensitivity to interest rates,” Harper said.

For example, on a recent ETF Trends survey, most financial advisors believe the Fed will begin hiking rates sometime in the second half of next year.

Investors, though, have been moving down the yield curve to hedge against rate risk. For instance, the so-called taper tantrum provided a test run for rising rates, but short-duration bonds only helped preserve capital with mediocre gains. [Short-Term Bond ETFs: Cool Kids at the Fixed Income Party]