Amid concerns that an interest rate hike from the Federal Reserve is a foregone conclusion this year, many investors have been skittish about fixed income exchange traded funds.
Inflows to equity ETFs have recently outpaced those to bond funds in significant fashion, but some fixed income ETFs are still being embraced by advisors and investors. Fixed income investors betting that a rate hike is imminent should move to the shorter end of the yield curve, a task that can be accomplished with exchange traded funds, such as the iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY).
SHY “has taken in $1.4 billion so far in July- by far the most of any fixed income ETF. In addition, it has seen positive flows come in each day as investors stash some cash possibly due to fears over the Greece and China debacles. The new cash has lifted SHY past the $10 billion mark for the first time. It is now the 9th largest fixed income ETF,” according to Bloomberg.
SHY’s modest yield is the tradeoff for gaining access to the ETF’s modest effective duration of 1.77 years. The yield and bond’s price have an inverse relationship, so bond funds with long durations would experience large price drops if rates were to rise. In contrast, short-duration bond funds will experience more muted volatility in case of sudden rate changes. [Focus on Short Duration Bond ETFs]
Since the start of the third quarter, only the SPDR S&P 500 ETF (NYSEArca: SPY), the world’s largest ETF, has added more new assets than SHY. SHY is nearly $500 million ahead of the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG), the next closest bond ETF in terms of third-quarter inflows.
By moving down the yield curve, short-duration bond ETFs will experience smaller swings in a rising rate environment. For instance, a 1% rise in interest rates would only correspond to modest, if any, losses for ETFs like SHY. With an expense ratio of just 0.15%, SHY is a cost-effective option for the fixed income investor looking to fight the scourge of rising rates. [Bond ETFs on the Cheap]
iShares 1-3 Year Treasury Bond ETF
Tom Lydon’s clients own shares of HYG, SHY and SPY.