Fixed income investors have been scrambling to adapt their portfolios to a changing environment as the Federal Reserve embarks on a tighter monetary policy in response to an expanding economy and rising inflation expectations. Exchange traded fund investors, though, can consider an actively managed bond strategy that is positioned to hedge the risks while providing steady returns.
For example, the actively managed Fidelity Limited Term Bond ETF (NYSEArca: FLTB) may help investors shift down the yield curve to short-term debt as a way to diminish the negative effects of inflation and hedge against interest rate risks.
“When it comes to our fund, we actually think higher rates are a good thing as we are able to reinvest at higher yields,” Rob Galusza, portfolio manager in the Fixed Income division at Fidelity, told ETF Trends in a call.
Galusza explained that FLTB has a focus on spread products, primarily corporate bonds that provide a yield premium over Treasuries securities. Consequently, the income advantage is what Fidelity’s management team is trying to use to outperform inflation.
“While we have been in a low-interest rate environment, we would expect short-term bond funds to provide returns that keep up with the purchasing power for shareholders as we return to a more normalized interest rate environment,” Galusza said.
FLTB is a short, intermediate corporate bond-focused portfolio primarily comprised of investment-grade debt securities, with a benchmark that is 1-5 year government debt, which has an effective duration of about 2.6 years and a 30-day SEC yield of 1.83%.
“We focus on corporate bonds, but we can also invest in other asset classes like structured products,” Galusza said. “We’ll invest in commercial mortgage-backed securities, asset-backed securities, agency mortgages, Treasuries and other government-related securities.”
The active ETF’s underlying portfolio’s credit grade profile includes AAA 16.7%, other investment-grade 77.5% and high-yield 2.4%. Debt holdings include a large 79.0% corporate portion, along with 10.9% mortgage, 6.8% government and 0.2% municipal bonds. Additionally, its duration profile is broken down to 48.4% short-term, 42.3% intermediate-term and 6.0% long-term.
Due to its actively managed mandate, the ETF can freely change its holdings, depending on the analysis of its portfolio managers, which may, for example, help it better hedge rate risk by focusing on a specific target duration.
“It’s an actively managed strategy and we look to outperform primarily through sector allocation and security selection,” Galusza said. “The portfolio does not tend to take a lot of duration difference to the benchmark, so we generally stay plus or minus a third of the year within the target duration of the benchmark.”
Additionally, the portfolio managers may target potential fixed income opportunities in the space. For instance, Galusza pointed out that the Fidelity team has favored the financial sector in its last portfolio rebalance.
“With respect to our focus over the last period, we’ve really had an overweight with financials,” Galusza said. “We’ve been constructive on banks with the improvement in the economy, the increased capital the banks have and now more recently with the new administration’s support on less regulation.”
Financials continue to make up a good chunk of FLTB’s portfolio, with top holdings including JPMorgan Chase & Co JPM 2.750 06/23/20 ’20 MTN at 2.0% of holdings, Goldman Sachs Group GS 2.625 01/31/19 MTN 1.9%, Bank of America BAC 2.650 04/01/19 MTN 1.9, Barclays BARC 3.250 01/12/21 MTN 1.6% and Citigroup C 2.500 07/29/19 1.5%.