Limit Duration Risk in Today’s Low Yield Environment with Bond ETFs

In the current interest rate environment, given the Federal Reserve’s turnaround from its rate-hiking measures in 2018 to its rate-cutting in 2019, it’s difficult to implement a bond strategy without knowing what the central bank will do in the future. In this current market environment, it’s best to limit duration via short duration bond ETFs.

2019 was a good year for bond funds as yields went lower and inversely, prices went higher.

“Do you own one or more bond funds? If so, 2019 was a very good year, but don’t expect that to continue,” wrote Mike Patton in Forbes. “You see, bonds do well when interest rates trend lower – as they did last year – but typically lose money when rates rise. And, with interest rates stuck at artificially low levels, at some point rates will rise, and bond funds will struggle to achieve a positive return.”

Going forward, however, uncertainty remains and getting too bogged down on the long end of the yield curve opens investors up to risks. As such, it’s best to limit duration.

“While it is beyond the scope of this article to delve into every nuance affecting the performance of bond funds, suffice to say that when yields rise – and they certainly will at some point, bond funds with shorter maturities and higher yields will provide greater principal protection than funds with lower yields and longer maturities,” Patton added. “Make sure you understand the risk in your bond funds so you can avoid this pitfall.”

Short-Term Bond ETFs to Consider

With the short-term rate adjustments being instituted by the Federal Reserve, investors can limit exposure to long-term debt issues and focus on maturity profiles. An example would be the SPDR Portfolio Short Term Corp Bd ETF (NYSEArca: SPSB), which seeks to provide investment results that correspond to the performance of the Bloomberg Barclays U.S. 1-3 Year Corporate Bond Index.

SPSB invests at least 80 percent of its total assets in securities designed to measure the performance of the short-termed U.S. corporate bond market. Ideally, shorter-term bond issues with maturities of three to four years are ideal to minimize duration exposure should the bull market enter a correction phase.

Another short-term bond ETF option is the iShares 1-3 Year Credit Bond ETF (NASDAQ: CSJ), which 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.

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