As the markets prepare for a rising interest rate environment, bond exchange traded fund investors may turn to more defensive strategies to prop up performance and mitigate rate risks.
Charles Schwab strategists argue that fixed income will offer opportunities as the Federal Reserve is set to hike interest rates, but the strategies may boring, reports Jeff Cox for CNBC.
Kathy Jones, Schwab’s chief fixed income strategist, points out that there are some pockets of value in the fixed-income market.
“The difference is really credit is priced better now,” Jones said. “Whether it’s priced well enough is the question, but it’s priced better than it was. That maybe presents some opportunity.”
Collin Martin, a Schwab director of fixed income, advises investors to adopt a barbell-oriented approach to bonds and steer away from high-yield debt since default risk for oil and mining companies is rising as commodity prices remain weak.
A barbell strategy refers to a form of long- and short-duration bond strategy that is popular during periods of rising interest rates. The barbell strategy tries to combine low-risk and high-risk assets while generating a better risk-adjusted return.
On one end of the barbell, investors can load up on cash, short-term bonds and floating rate investment grade debt.
As a cash alternative, investors may turn to ultra-short-duration bond ETFs, such as the PIMCO Enhanced Short Maturity ETF (NYSEArca: MINT), Guggenheim Enhanced Short Duration Bond (NYSEArca: GSY), SPDR SSgA Ultra Short Term Bond ETF (NYSEArca: ULST) and iShares Short Maturity Bond ETF(NYSEArca: NEAR). These bond ETFs have a duration of less than 1 year.
For a slightly longer duration, investors can turn to short-term bond ETFs, such as the Vanguard Short-Term Bond ETF (NYSEArca: BSV) and iShares 1-3 Year Treasury Bond ETF (NYSEArca: SHY), which track one- to three-year Treasuries.
The iShares Floating Rate Bond ETF (NYSEArca: FLOT), SPDR Barclays Investment Grade Floating Rate (NYSEArca: FLRN) and Market Vectors Investment Grade Floating Rate (NYSEArca: FLTR) all track investment-grade bonds with a floating rate component, which automatically adjust at periodic intervals in response to changes in the interest rates.
On the other end of the barbell strategy, investors can turn to intermediate term, corporates and U.S. Treasuries.
Investment-grade corporate bond exposure include the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD), Vanguard Intermediate-Term Corporate Bond ETF (NYSEArca: VCIT) and SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEArca: ITR).
For intermediate U.S. Treasuries exposure, investors can consider the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), Schwab Intermediate-Term U.S. Treasury ETF (NYSEArca: SCHR) and Vanguard Intermediate-Term Government Bond ETF (NYSEArca: VGIT).
Jones also believes more conservative municipal bonds, notably those that focus on general obligation debt, are also a solid choice. General obligation bonds are backed by a municipality’s taxing power, or typically from property taxes, for debt service payments. The iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB), SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI) and Market Vectors Intermediate Municipal Index ETF (NYSEArca: ITM) provide broad exposure to intermediate-duration municipal debt.
For more information on the fixed-income market, visit our bond ETFs category.