In the parlance of capital markets, the higher-for-longer phrase has yet to dissipate. The economy continues to run hot and yields rise. So fixed income investors may want to ponder using short-term and corporate bonds as part of their portfolio.
As noted in a recent Barron’s article, higher yields at the long end of the yield curve as opposed to the short end is causing an inversion. This is one of the warning flags economists use to signal a potential recession. As inflation remains and yields stay elevated, a pivot to bonds with shorter maturities may be the optimal move. Fixed income investors can lock in yields now before a data-dependent Federal Reserve eventually cuts rates.
“A big driver of duration decisions is the yield curve. If I’m thinking of going from a shorter-term bond to a longer one, am I getting better returns?” said Dave Plecha, global head of fixed income at Dimensional Fund Advisors. “Why would I hold a more volatile security with a lower yield and return?”
Given this notion, an ETF option to consider is the Vanguard Short-Term Bond Index Fund ETF Shares (BSV). The fund tracks the Bloomberg U.S. 1-5 Year Government/Credit Float Adjusted Index. That said, the fund’s holdings include all medium and larger publicly issued U.S. government, investment-grade corporate, and investment-grade international dollar-denominated bonds with maturities between one and five years.
Corporate Bonds Look Compelling
The Barron’s article also mentioned corporate bonds, especially for those looking to add yield while accepting the additional credit risk. Investors can mitigate that risk, however, by opting for investment-grade debt.
“You can buy names that resonate in the equity market and get a nice fixed-income return. There are certainly opportunities in corporate bonds,” said Jonathan Birnbaum, founder & CEO of OpenYield, an online bond marketplace for retail investors.
To also mitigate rate risk before the eventual rate cuts, investors can opt for short-term corporate bonds that are investment-grade. This is available in the Vanguard Short-Term Corporate Bond Index Fund ETF Shares (VCSH), which seeks to track the the performance of the Bloomberg U.S. 1-5 Year Corporate Bond Index. The index includes U.S.-dollar-denominated, investment-grade, fixed-rate, taxable securities issued by industrial, utility, and financial companies, with maturities between one and five years.
Both funds feature a low expense ratio of 0.04%, appeasing cost-conscious investors.
For more news, information, and analysis, visit the Fixed Income Channel.