By John Lunt, Lunt Capital

Most investors view bonds as boring.  If clients don’t say it out loud, the glazed look that they give you when the topic comes up speaks volumes. There is nothing wrong with bonds being boring!  Investors associate bonds with boring because they expect less risk and less volatility when compared to equities.  Bonds are a critical building block in asset allocation, and they may act as valuable diversifiers.  Not all bonds behave in a boring way—it is important to make sure that bond allocations are not unknowingly masquerading as fixed income with equity-like characteristics (think high yield, emerging market debt, and long duration bonds).

Bond ETFs have opened exciting new asset allocation strategies and tactical tools when building portfolios.  Bond ETFs can now be very deliberate and targeted.  It’s exciting what you can do in your boring bond portfolio!  Lunt Capital has owned in the past or currently owns every ETF mentioned in this article.  This is not a recommendation to buy or sell any ETF.  Past performance of any ETF is no indication of its future return.  As with any investment, there are various risks associated with ETFs that a potential investor should review prior to investment.  This is far from our complete opportunity set, but it is intended to give a flavor of what is now available.

Go Low Cost, Total Market

Capturing total bond market beta has never been easier or less expensive.  The major ETF firms have made this type of allocation very efficient, and the Vanguard Total Bond Market ETF (BND) and the iShares Core U.S. Aggregate Bond ETF (AGG) are popular choices.  There are now several total market bond ETFs that focus on shorter duration bonds.

Pull a Lever to Tilt Fixed Income Beta (Curve, Credit, & Currency)

In our opinion, there are three major ways to tactically tilt bond allocations.  This includes moving across the yield curve, moving across the credit spectrum, and moving across the currency spectrum.  There are many ETFs that allow the investor to use fixed income beta to tilt exposure in bond portfolios.  For example, a move across the yield curve might include an opportunity set of iShares 1-3 Year Treasury Bond ETF (SHY), iShares 7-10 Year Treasury Bond ETF (IEF), and iShares 20+ Year Treasury Bond ETF (TLT).  An investor’s view of interest rates can easily be reflected by targeting bond duration.  The credit spectrum offers investors the ability to take a view on whether credit spreads will widen or tighten.  Investors could choose between the iShares iBoxx Investment Grade Corporate Bond ETF (LQD) or the  SPDR Bloomberg Barclays High Yield Bond ETF (JNK).  Vanguard offers a Mortgage-Backed Securities ETF (VMBS) and there are multiple providers that offer muni-bond ETFs with varying degrees of credit risk.  Last, allocating to bond ETFs denominated in foreign currencies is an underappreciated opportunity to both strategically and tactically tilt bond allocations.  Bond ETFs like the SPDR Bloomberg Barclays International Treasury Bond ETF (BWX) offers bonds denominated in foreign currencies that may benefit as the U.S. Dollar weakens.

Investors can obviously combine these tactical levers.  For example, the PowerShares Emerging Markets Sovereign Debt ETF (PCY) has a long duration and takes on meaningful credit risk by investing in emerging market debt, but it only buys bonds denominated in U.S. Dollars.  In contrast, the WisdomTree Emerging Markets Local Debt Fund (ELD) holds emerging market bonds, but has a lower duration than PCY and ELD holds emerging market bonds in their local currency.

Capture a Theme or Opinion with a Unique Strategy Within the ETF

One of the great ETF innovations in recent years has been the entrance of bond ETFs that offer investors the ability to efficiently capture a theme or opinion within the ETF.  PowerShares brings “smart beta” to bonds with the PowerShares Fundamental Investment Grade Corporate Bond ETF (PFIG).  There are a variety of interesting bond strategies embedded in ETFs, including VanEck’s  Vectors Fallen Angel High Yield Bond ETF (ANGL).  Investors concerned about rising rates may look at floating rate note ETFs like the SPDR Bloomberg Barclays Investment Grade Floating Rate ETF (FLRN) or Bank Loan ETFs like PowerShares’ Senior Loan ETF (BKLN).  Additionally, there are now an array of interesting ETFs that provide hedged interest rate exposure.

Investors wanting to build bond ladders with targeted durations may look at Guggenheim’s BulletShares.  Investors with views on the market’s mispricing of inflation expectations may purchase Treasury Inflation Protected Securities such as the iShares TIPS Bond ETF (TIP) or the Vanguard Short-Term Inflation-Protected Securities ETF  (VTIP).  If an investor expects the U.S. Dollar to strengthen, Vanguard offers its Total International Bond ETF (BNDX) that hedges the foreign currency exposure.  On the opposite side, if an investor wants explicit currency exposure, he or she could purchase the SPDR Bloomberg Barclays Short Term International Treasury Bond ETF (BWZ) or even the actual foreign currencies through the Guggenheim CurrencyShares Euro Trust (FXE) or Japanese Yen Trust (FXY).

Go Active Within an ETF

Many investors concerned about passive bond beta can now allocate to a variety of active bond ETFs.  Rather than track a specified index, these active ETFs allow discretion for the bond manager to buy and sell bonds within the ETF.  This allows investors access to leading bond managers and firms.  First Trust has been a leader in active ETFs, and has partnered with TCW to offer the First Trust TCW Opportunistic Fixed Income ETF (FIXD).  SPDR ETFs has partnered with DoubleLine to offer the SPDR DoubleLine Short Duration Total Return Tactical ETF (STOT) and SPDR DoubleLine Total Return Tactical ETF (TOTL).  PIMCO’s active bond ETFs include its flagship Active Bond Exchange Traded Fund (BOND), while Guggenheim offers a Total Return Bond ETF (GTO).  J.P. Morgan has recently launched its J.P. Morgan Global Bond Opportunities ETF  (JPGB).  Investors that want fixed income rotation within an ETF may look to the SPDR Dorsey Wright Fixed Income Allocation ETF (DWFI).  Duration-sensitive investors have a variety of options, including the First Trust Enhanced Short Maturity ETF (FTSM), the First Trust Low Duration Opportunities ETF (LMBS), the J.P. Morgan Ultra-Short Income ETF (JPST) and the PIMCO Enhanced Short Maturity Active Exchange Traded Fund (MINT).

This is far from a comprehensive list of Bond ETFs, but it provides a flavor of the tremendous innovation and valuable tools available for asset allocation and portfolio construction.  It’s exciting what you can do in your boring bond portfolio!

John Lunt is the President of Lunt Capital Management, a participant in the ETF Strategist Channel.

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