These funds can help bond investors cope.
The Federal Reserve once again raised interest rates, making the sixth increase since the end of 2015, and the central bank telegraphed another two increases could be likely by the end of 2018. That makes things very difficult for bond investors. Most investors know there is an inverse relationship between interest rates and the value of bonds. As rates rise, older bonds with lower yields have lower demand and the new bonds with higher yields attract the buyers. The good news is a strategic approach can mitigate these pressures. Here are seven tactics as the Fed continues its march toward higher interest rates.
Vanguard Short-Term Treasury ETF (ticker: VGSH)
If you’re worried about continually rising interest rates, one way to limit your exposure to problems in the bond market is to shorten the duration of your investments. Bonds that are nearing maturity are much less sensitive to potential changes a year or two down the road. This Vanguard exchange-traded fund does that perfectly, with an average maturity of just two years and every penny of the portfolio in rock-solid U.S. government bonds.
Current yield: 2.2 percent
iShares 1-3 Year Credit Bond ETF (CSJ)
Short-term Treasury bonds have a lot of stability. However, the trade off by going with this asset class is that you don’t get paid very much in distributions. If you want to stay short term with your investments to avoid interest-rate risk but want more yield, then consider this corporate bond fund from iShares. Investment-grade bonds from top corporations like JP Morgan Chase & Co. (JPM) and Goldman Sachs Group (GS) are not quite as bulletproof as U.S. Treasurys, so you get a bit more yield, but they are still pretty close to a sure thing.
Current yield: 2.6 percent
SPDR Barclays Short Term Municipal Bond (SHM)
Another interesting way to squeeze a bit more yield out of short-term bonds is to focus on municipal government debt instead of U.S. Treasurys. For a long time, Wall Street has demanded a risk premium from smaller, local governments for this debt despite the fact that municipal bonds have historically had a lower default rate than even investment grade corporate debt. You can take on just a hair more risk by going with local government debts in exchange for a modest bump in yield. Best of all, depending on your home state and terms of the bonds, there may even be tax advantages.
Current yield: 2.6 percent
PIMCO Total Return Bond ETF (BOND)
If you acknowledge that short-term strategies limit your downside but still can’t stomach a yield less than 3 percent, here is a great alternative. The idea is simple: Put a smart manager in charge of the fund, and go where the opportunity is. This includes a mix of corporates, Treasurys, emerging market debt and other instruments. There is admittedly more risk in this approach, and as an active fund you’ll pay more in expenses — the fund costs 0.61 percent annually or $61 on every $10,000 invested. However, the ability to make tactical decisions in an evolving bond market can be invaluable.
Current yield: 3.1 percent
iShares 0-5 Year High Yield Corporate Bond ETF (SHYG)
Another strategy for the rising-rate environment is to stay short term, but to focus on high-yield investments that will pay a significant amount even if the duration isn’t very long. That’s what the SHYG fund offers, with a yield that is more than double the typical short-term bond fund. But remember high-yield bonds are called “junk” bonds for a reason. There is a much higher risk of default, and if the economy rolls over or if specific holdings hit a snag, the big yield may not compensate for your losses.
Current yield: 5.6 percent
SPDR Bloomberg Barclays Short Term International Treasury Bond ETF (BWZ)
The flip side of the trade is you simply want security during a period of interest rate increases and volatility in the bond market. In this case, the BWZ fund is a great choice because it covers the top-rated government bonds from non-U.S. countries like Japan and Belgium. This is important because while the Federal Reserve is raising rates, the European Central Bank and the Bank of Japan are continuing their stimulative monetary policies. While that means a lower yield, it also means a bit more certainty — and less risk of declines based on Fed actions.
Current yield: 2.3 percent
Schwab US TIPS ETF (SCHP)
Some investors believe that the economy and the interest-rate environment is fundamentally changing. If that’s your concern, then consider a strategic play in Treasury inflation protected securities, or TIPS, via this Schwab ETF. TIPS are a unique form of bond benchmarked to the inflation rate. As inflation heats up, these bonds yield more. That may be attractive to investors seeking an asset tied to something other than interest rates. Of course, inflation has been muted in recent years so the current yield isn’t great. But this fund is insurance against future inflation more than the promise of immediate yield.
Current yield: 2 percent
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7 Bond Funds to Buy as Rates Rise originally appeared on usnews.com
