Fight Negative Rate Risk with These 3 ETFs

In certain areas around the globe, government debt is producing negative yields, prompting investors to rethink the strategy of bonds as a safe haven. While that risk has yet to touch U.S. borders, corporate debt is heading into that territory, but certain exchange-traded funds (ETFs) can give investors the positive yield they desire.

Corporate debt is heading into the $1 trillion mark and per a CNBC report, “estimates of sovereign debt in that category put the total in excess of $15 trillion, a number that has been escalating over the past several years while central banks drive interest rates to zero and below.”

As that debt continues to rise, the interest rate risk is rising with it.

“The interest rate risk that these bonds carry is huge,” said Jim Bianco, founder of Bianco Research.. “The financial system doesn’t work with negative rates. If the economy recovers, the losses that investors would take are unlike anything they’ve ever seen.”

The best case-in-point example is Germany, which has a number of benchmark bonds that are yielding below zero percent. Bianco says the European Central Bank’s penchant for funneling more cash into the financial system is a reason for these negative yields.

“They’ve so flooded their financial system with money that there’s not enough alternatives,” he said. “That’s why you have people paying such astronomical prices that you wind up with negative yields.”

According to data from Bank of America Merrill Lynch, $27.8 trillion of non-U.S. dollar investment grade global debt is currently yielding only 0.11 percent.

“We continue to think there is a wall of new money being forced into the global corporate bond market,” said Hans Mikkelsen, credit strategist at Bank of America Merrill Lynch. “The trigger is lower interest rate volatility or simply the passage of time, as a lot of foreign investors are being charged (negative yields) for being underinvested.”

However, there are still options to consider for quality bond exposure, such as the following:

  1. iShares 1-3 Year Credit Bond ETF (NASDAQ: CSJ): CSJ tracks the investment results of the Bloomberg Barclays U.S. 1-3 Year Credit Bond Index where 90 percent of its assets will be allocated towards a mix of investment-grade corporate debt and sovereign, supranational, local authority, and non-U.S. agency bonds that are U.S. dollar-denominated and have a remaining maturity of greater than one year and less than or equal to three years–this shorter duration is beneficial during recessionary environments.
  2. SPDR Blmbg Barclays Investment Grade Floating Rate ETF (NYSEArca: FLRN): FLRN seeks to provide investment results that mimic the performance of the Bloomberg Barclays U.S. Dollar Floating Rate Note < 5 Years Index. At least 80 percent of assets will go towards securities that include U.S. dollar-denominated, investment grade floating rate notes. This floating rate component can take advantage of short-term rate adjustments by the Federal Reserve, while at the same time, protect the investor against credit risk with investment-grade issues and a duration of less than five years.
  3. iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD): LQD seeks to track the investment results of the Markit iBoxx® USD Liquid Investment Grade Index composed of U.S. dollar-denominated, investment-grade corporate bonds. LQD allocates 95 percent of its total assets in investment-grade corporate bonds to mitigate credit risk.

For more trends in fixed income, visit our Fixed Income Channel.