The fixed-income market has played second fiddle to equities, but there are still areas of opportunity that bond exchange traded fund investors can look to.
“The fixed income market remains challenging, but market technicals have improved as demand from banks and others has absorbed the increased supply as the Federal Reserve (Fed) normalizes its balance sheet. The key is being selective: We think mortgage-backed security valuations remain attractive and prefer agency MBS over credit, TIPS over Treasuries and investment grade over high yield within credit,” Christopher Dhanraj, Director and Head of ETF Investment Strategy for iShares, said in a note.
Fixed income markets have been pressured in a rising rate environment, but Dhanraj argued that market dynamics for agency mortgage-backed securities have improved as demand from banks, REITs and overseas purchasers have helped offset increased supply. MBS valuations also remain attractive. While MBS spreads tightened on declining rate volatility in recent years, the securities look attractive compared to other high-quality corporate credit – agency MBS spreads are trading near the midpoint of their historical range whereas investment grade credit remains closer to historical tights.
Top Fixed-Income Plays
Fixed-income investors interested in gaining exposure to mortgage-backed securities can look to something like the iShares MBS ETF (NYSEArca: MBB), which tracks investment-grade mortgage-backed pass-through securities issued and/or guaranteed by U.S. government agencies.
Additionally, Dhanraj continues to favor a shorter-duration and an up-quality bias in fixed income allocations, pointing to agency MBS over credit, Treasury Inflation Protected Securities over Treasuries and investment grade over high yield within credit.
ETFs that track Treasury inflation protected securities such as the iShares TIPS Bond ETF (NYSEArca: TIP) track a type of Treasury security that is indexed to inflation as a way to shield investors from the negative effects of inflation. The securities’ par value rises with inflation as measured by the Consumer Price Index while interest rate remains fixed. TIPS also offer investors another layer of diversification as many aggregate bond funds exclude TIPS from their holdings.
Investors interested in short-term, investment-grade credit may also look to something like the iShares 0-5 Year Investment Grade Corporate Bond ETF (NasdaqGM: SLQD), the short-term version of the popularly traded iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD).
For more information on the fixed-income market, visit our bond ETFs category.