Low-Duration Intermediate Fixed Income Serves as Attractive Diversifier

It’s been a tough time for bonds. Fixed income markets were challenged in 2021, and with the Fed indicating that it could raise rates as many as three times this year, it looks as though 2022 won’t be much better for the asset class.

But considering that equity markets are volatile and interest rates are currently low, limited-duration intermediate fixed income ETFs — i.e., bond funds with ranges of four and seven years — could serve as a strong diversifier away from equity risks, especially when equities markets continue to be more volatile.

While the potential for rising rates is likely to be a headwind for fixed income assets, bond funds still play the important role of diversifier against equity risk. Strategies with shorter duration than traditional bond benchmarks like the Bloomberg Aggregate Bond Index may help mitigate declines if rates rise. Strategies that offer higher yields can also help offset price declines. Emerging markets bonds diversify the portfolio, offer income, and are not directly exposed to U.S. monetary policy.

Given that some investors are getting spooked by choppy equity markets, many are beginning to give this subset of bond strategies a closer look.

For example, American Century Investments has several fixed income funds on ETF Database: the Avantis Core Municipal Fixed Income ETF (AVMU), the American Century Emerging Markets Bond ETF (AEMB), the American Century Diversified Corporate Bond ETF (NYSEArca: KORP), and the Avantis Core Fixed Income ETF (AVIG). And while these bond funds are quite distinct from one another — one invests in municipal bonds, another in emerging markets, and the other two in investment-grade corporate bonds and the core aggregate, respectively — the one common denominator for all of them is that there’s a tilt towards more intermediate and limited duration.

“These strategies do have a more limited duration, so they have lower interest rate sensitivity,” said Sandra Testani, vice president of ETF product and strategy for American Century Investments.

Testani added that the surge in research in these funds may be less of an indication that investors have become excited over fixed income and more of a sign that they foresee a challenging time for equities as well as for bonds — and are therefore looking for that downside protection. “This is more about diversification against equities and the expected safety than a strong feeling of excitement over fixed income,” Testani said.

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