With the Federal Reserve apparently eyeing a 2022 interest rate increase, fixed income investors are once again contending with curveballs from the U.S. central bank.

The lay of the bond land in 2021 is a vexing cocktail of low interest rates, depressed credit spreads, and the specter of a looming rate hike. In other words, duration risk is now very much part of the equation for bond investors, and that’s problematic at a time when low yields are so prevalent. With all that in mind, it could be an ideal time for income-starved investors to consider short-term high-yield bond funds.

“Given their shorter durations, this subset of high-yield bond strategies typically does better than the broader category during interest-rate spikes. When rates rose over the first 10 months of 2018, the typical short-duration high-yield offering returned 2.0%, outpacing its broader category’s median return of 0.4%. More recently, when rates spiked in the first quarter of 2021, short-duration offerings posted a typical return of 1.7%, 75 basis points better than the group norm,” says Morningstar analyst Sam Kulahan.

The average yield on a short-duration junk bond fund resides around 2.7%. While that’s lower than what investors find on traditional high-yield corporate debt funds, 2.7% is excellent by today’s yield standards, and it’s a solid percentage when considering that duration risk is lower. Additionally, short-duration junk bond ETFs usually feature less credit risk than standard duration equivalents.

“Short-duration high-yield funds also typically take on less credit risk than traditional high-yield strategies,” notes Kulahan. “As of June 2021, the typical short-duration high-yield offering held 5 percentage points more in BB rated debt, which is the highest rating for junk-rated debt, than the high-yield category norm. The typical short-duration high-yield fund also held 15 percentage points less in debt rated B and below than the high-yield category median.”

Examples of short-duration high-yield corporate bond exchange traded funds include the iShares 0-5 Year High Yield Corp Bond ETF (NYSEArca: SHYG), the SPDR Bloomberg Barclays Short-Term High Yield Bond ETF (NYSEArca: SJNK), and the PIMCO 0-5 Year High Yield Corp Bond ETF (NYSEArca: HYS).

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