With plenty of assistance from the Federal Reserve’s refusal to raise interest rates to this point in 2016, fixed income exchange traded funds have been favored destinations for advisors and investors. Four of this year’s top 10 asset-gathering ETFs are bond funds, but some market observers are concerned investors are glossing over underlying weakness in the bond market.
Investors may be attracted to the cheap valuations and wider yield premiums that these bonds offer over safe-haven government bonds after benchmark yields on 10-year Treasuries dipped back toward all-time lows. Moreover, the rebound in energy prices could have reassured investor fears of a potential defaults in the energy space.
Related: If Rates Rise, Look to These Junk Bond ETFs
The iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT) has been a popular Treasury bond play for yield generation over the past few years after the Federal Reserve implemented near-zero interest rates and a robust bond purchasing program. However, TLT comes with a 17.72 year duration – a 1% increase in interest rates would translate to about a 17.72% decline in the fund’s price.
“Other bond market ETFs seem to be sending the same message, including the iShares iBoxx $ Investment Grade Corporate Bond (LQD), the iShares Core U.S. Aggregate Bond ETF (AGG) and the iShares S&P National AMT-Free Municipal Bond Fund (MUB). Each one of these ETFs now sport record high readings in their on-balance volume charts,” reports Michael Kahn for Barron’s.
[related_stories]Aggregate bond ETFs, such as the iShares Core U.S. Aggregate Bond ETF (NYSEArca: AGG), which tracks the Barclays Aggregate Bond Index, are favorites among advisors and investors, but these funds are often heavily allocated to Treasuries, implying some level of vulnerability should interest rates climb.
Investment-grade corporate bond ETFs have also become popular plays in 2016. For instance, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) is one of this year’s top asset-gathering bond ETFs that is not dedicated to U.S. government bonds.
Related: 28 ETFs for Investment-Grade Corporate Bond Exposure
Further fueling the rise in the corporate bond market, supply and demand fundamentals are supporting the forward momentum. Deutsche Bank AG analysts have also pointed out that mutual funds have acquired $275 billion worth of bonds sold by companies with relatively strong balance sheets in 2015 or far outstripping the net supply of new issues, Bloomberg reports.
“The bond market action suggests market participants are just not happy right now, and they seem to be getting even less happy. Therefore, despite the good news coming from the stock market, all is not well,” adds Barron’s.
For more information on the fixed-income market, visit our bond ETFs category.
iShares 20+ Year Treasury Bond ETF
Tom Lydon’s clients own shares of LQD and TLT.