With all the talk about the Federal Reserve nearing its first interest rate cut in September, it’s unsurprising that many fixed income investors are considering adding more duration to their portfolios. Some experts are even encouraging that move. This makes sense because longer-dated bonds are the ones most levered to changes in rates.
On the other hand, there’s a case for maintaining some exposure to short duration fare, signaling exchange traded funds such as the Eaton Vance Short Duration Income ETF (EVSD). EVSD has an effective duration of just 2.05 years and is actively managed so that it can respond more nimbly to changes in interest rates than index-based counterparts.
The $176.41 million EVSD holds a mix of corporate bonds, mortgage-backed securities (MBS), and Treasurys. Its low duration explains why the fund gained traction with advisors and investors as the Fed dithered on lowering rates. Indeed, high rates boosted the allure of ETFs such as EVSD. Still, that doesn’t imply that now is the time to ignore these funds. The opposite might be true.
EVSD Can Be an Insurance Policy
Over the near term, maintaining exposure to an ETF like EVSD could be a practical move because there are no guarantees the Fed will comply with rate cuts or cut to the extent many investors are hoping for.
September rate cuts “may or may not happen. The market has been overly optimistic on rate cuts before; at the end of 2023, for example, there was widespread market sentiment that the Federal Reserve would cut rates multiple times starting in early 2024,” Morningstar’s Amy Arnott noted.
There’s another reason EVSD could maintain near-term utility. Many novice investors don’t realize this, but simply because the Fed lowers interest rates, that’s not a guarantee that yields will decline on longer-dated Treasurys.
In fact, due to the swelling national debt, those yields could remain elevated even if interest rates decline. Under that scenario, market participants who flocked to long-duration fares when rates declined could be left disappointed. Plus, short-term bonds, such as those found in EVSD, fit more seamlessly in various portfolios.
“Indeed, investors in long-term bond categories have often been tripped up by buying and selling at the wrong time. For example, Morningstar’s long-term government-bond category attracted significant net inflows during 2021. This was right before the bond market’s historically painful drawdown in 2022,” adds Arnott. “Because of this pattern, investor return gaps (the difference between what investors actually earn and the fund’s reported total returns) are much larger for long-term government-bond funds than other bond-fund categories.”
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