Given the shifting fixed-income environment as the Federal Reserve embarks on raising interest rates, bond investors should consider ETFs that track short-term corporate bond with a focus on higher quality.

“Expected returns on lower-risk assets have risen alongside the Fed’s policy rates, reducing the need to stretch for yield into higher-risk sectors. This has triggered volatility in the fixed income market – and underpins our defensive stance: a preference for U.S. short duration and higher-quality credit,” Jeffrey Rosenberg, Chief Fixed Income Strategist for BlackRock Investment Institute, said in a research note.

The Fed’s Tighter Monetary Policy

The Federal Reserve is expected to adhere to its tighter monetary policy. During the Fed’s annual Jackson Hole, Wyoming meeting, Federal Reserve Chairman Jerome Powell defended the central bank’s strategy of gradually raising interest rates, the Wall Street Journal reports.

The Fed faces two major risks of “moving too fast and needlessly shortening the expansion, versus moving too slowly and risking a destabilizing overheating,” Powell said. “I see the current path of gradually raising interest rates as the [Federal Open Market Committee’s] approach to taking seriously both of these risks.”

Related: ETF Strategies to Navigate Rising Rate Conditions

With the Federal Reserve raising interest rates, yields on short-term debt have increased and are closing in on yields for later-dated debt. For example, yields on 2-year Treasuries were hovering around 2.62%, compared to yields on benchmark 10-year notes at 2.82%.

Consequently, the expected returns on lower-risk assets now look more attractive and diminished the need for investors to stretch toward riskier assets for yields. For example, the iShares Short-Term Corporate Bond ETF (NasdaqGM: IGSB) has a 2.7 year effective duration and a 3.14% 30-day SEC yield. The iShares 0-5 Year Investment Grade Corporate Bond ETF (NasdaqGM: SLQD) has a 2.33 year duration and a 3.19% 30-day SEC yield. The iShares ESG 1-5 Year USD Corporate Bond ETF (NasdaqGM: SUSB), a bond ETF with a socially responsible investment theme, also comes with a 2.7 year duration and a 3.23% 30-day SEC yield.

For more information on the fixed-income market, visit our bond ETFs category.

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