Advisors have choices to face with their fixed income allocation. Should they take on credit risk to be rewarded with a high level of income? What about taking on interest-rate risk and owning longer-duration bonds? Using ETFs, they can get a good combination of these risk-and-reward alternatives that match their priorities.
Heading into the fourth quarter, fixed-income-minded advisors were relatively risk averse according to VettaFi sentiment analysis. During a late September webcast with Federated Hermes, we asked advisors a key question: “Where do you think the best opportunity for fixed income is over the next year?” The results were close, with short-term Treasuries garnering 40% of the results and investment-grade credit nabbing 36%. Far fewer people thought long-term Treasuries (22%) or high yield (12%) were worth the risk.
This contrasts with the industry demand for the iShares 20+Year Treasury Bond ETF (TLT) in the first nine months of 2023. The long-term Treasury ETF’s $16 billion in net inflows made it easily the most popular fixed income product. Investors were not being rewarded, as TLT was down 10%. Meanwhile, the Vanguard Total Bond Market ETF (BND) added $13 billion of new money this year. Unfortunately, its total return was down fractionally in 2023 as of the end of September.
See related: “Dave Nadig and Todd Rosenbluth on the Year of Fixed Income“
With many tools available, advisors can also choose to both limit their clients’ interest-rate risk and their credit risk. There’s an array of low-cost index-based short-term investment-grade bond ETFs. Thanks to the Fed-hiking program, these funds offer a nice yield.
Vanguard’s Short-Term ETF Has Been Out of Favor Despite Offering Stability
The Vanguard Short-Term Corporate Bond ETF (VCSH) has $36 billion in assets and sports an attractive 5.7% 30-day SEC yield. This high level of income is available despite the fund’s modest 2.6 years of average duration. The portfolio is primarily a mix of moderate-quality investment-grade bonds — 47% in securities rated A and 45% in those rated BBB.
VCSH has been notably out of favor in 2023, with net outflows of $4.5 billion. However, the pace has slowed recently, as just $200 million was redeemed in the past month.
The iShares 1-5 Year Investment Grade Corporate Bond ETF (IGSB) has $22 billion in assets and has lots of similarities to VCSH. The fund’s yield is 5.8% and its duration is 2.6 years. From a credit perspective, 45% of assets are in bonds rated both A- and BBB.
Investors have stayed more loyal to IGSB than VCSH. The ETF has incurred just $775 million of net outflows in 2023. However, $630 million of this occurred in the past month.
SPSB Is Smaller Than Peers But Performing Better in 2023
The SPDR Portfolio Short Term Corporate Bond ETF Bond ETF (SPSB) has $7.2 billion in assets and also has a 5.7% yield. SPSB’s average duration of 1.8 years is lower than its peers though its credit quality (47% in A and 45% in BBB bonds) is similar.
In 2023, the smaller SPSB has $300 million of net outflows, with approximately $50 million coming out in the last month.
All three index-based short-term investment-grade bond ETFs are available for a miniscule 0.04% expense ratio. Through September 30, SPSB’s 2.4% year-to-date total return was the highest. IGSB and VCSH rose 2.2% and 1.9%, respectively, a reminder that fees only matter so much. However, the low-single-digit gains this year are all much stronger than the loss incurred by more popular products.
While this trio of bond ETFs have been out of favor in 2023, we think their strong combination of stable income with moderate credit and interest-rate risk adds to their appeal. Low-cost bond ETFs can serve as a diversified building block of a portfolio. Advisors should consider bucking the industrywide trend and look closely at these offerings.
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