Rate hikes pose a challenge for bond investors.
The Federal Reserve is wrapping up another important meeting and it’s clear the central bank is embarking on a long-term strategy of tighter monetary policy and rate hikes. This creates a troublesome dynamic for bond investors. While higher rates mean newer bonds offer better yields, the attractiveness of those newer bonds make older bonds worth less. And the principal value of holdings declines in value. The widely held iShares 20+ Year Treasury bond ETF (ticker: TLT) lost almost 5 percent over the last year — more than offsetting potential interest income. Balancing principal declines while seeking yield is difficult, but not impossible. These eight ETFs can help.
SPDR Portfolio Short Term Treasury ETF (SPTS)
While long-term bonds can lose value as rates rise, short-term bonds are less susceptible to volatility. The more recent the maturity, the less money that’s left on the table when compared to newer securities offering better income potential. By focusing solely on U.S. Treasury bonds with a maturity of one to three years, SPTS is a rock-steady investment that barely moves up or down. The yield isn’t quite as high as in a longer-term fund, but you can at least be sure your money is safe even amid a choppy bond market.
Current yield: 1.9 percent
Vanguard Short-Term Corporate Bond ETF (VCSH)
Corporate bonds aren’t quite as bulletproof as U.S. Treasury bonds, meaning a slightly higher yield. But short-term debt from some of the biggest corporations, including CVS Health Corp. (CVS) and Goldman Sachs Group (GS), are still very safe investments. There is a bit more “wiggle” in this fund, with a maturity range that stretches out to five years, in addition to the slightly elevated risk of corporate bonds. But a long-term chart shows a very stable performance — and with a yield that’s better than many dividend stocks.
Current yield: 3.3 percent
Schwab U.S. TIPS ETF (SCHP)
A major reason interest rates get pushed higher is to cool inflation. Rather than simply focus on the rate front, however, it may be worthwhile for investors to consider TIPS — Treasury Inflation Protected Securities. This special class of bond pays a small interest payment on its face, but adjusts the principal value of the bond higher twice each year depending on the rate of inflation. If inflation doesn’t materialize, then you don’t see a significant adjustment and your investment goes nowhere. But as a defensive play, there are worse ideas than TIPS in a rising-rate environment.
Current yield: 2.3 percent
ProShares Inflation Expectations ETF (RINF)
If you really worry about inflation, then this dynamic ProShares fund offers a bit of a twist on the typical TIPS play. In addition to taking long positions in TIPS, it also takes “duration adjusted” short positions in U.S. Treasury bonds. The idea is simple: Not only are you trying to make a bit of money as inflation rises, but you’re also trying to make a bit of money as interest rates rise and thus drive down the principal value of conventional Treasurys. Both those things have to happen, so there’s a bit more risk in this fund.
Current yield: 3 percent
Sit Rising Rate ETF (RISE)
Another interesting play on rising interest rates and falling bond values is RISE, positioned as a defensive instrument to hedge a bond portfolio, almost as a kind of insurance. It does this by betting against Treasurys using futures contracts and options on government bonds ranging from two to 10 years. If rates rise, these securities lose value. Note there are plenty of periods where rates have declined for weeks and months despite talk of a tighter monetary policy, so don’t fall into the trap of thinking this ETF is always a sure thing. Also, short-side bets don’t offer yield to investors.
Current yield: None
iShares Floating Rate Bond ETF (FLOT)
This iShares fund offers exposure to floating-rate bonds, which are securities with interest payments that adjust to changes in interest rates — much like adjustable-rate mortgages or credit cards with variable rates. The big difference is FLOT securities increase the yield they deliver to investors, not increase the amount of interest consumers must pay. These bonds are less likely to lose value as rates rise because they are flexible and keep up with the changes, unlike bonds with a fixed yield.
Current yield: 2.5 percent
Invesco LadderRite 0-5 Year Corporate Bond Portfolio (LDRI)
Another strategy when interest rates are rising is to “ladder” your bonds — that is, plan so individual holdings don’t mature at once. Investors can slowly transition from older to new bonds, akin to averaging-in to a stock by investing money over time instead of one lump sum. This is a great way to smooth out risk, but can be complicated for individual investors who aren’t equipped for frequent bond purchases. LDRI handles this chore and creates a curated portfolio across different maturity dates.
Current yield: 2.7 percent
Pimco ETF Trust (BOND)
If it’s hard to decide which tactic you prefer, then go with the tried-and-true method where an investment manager makes those decisions. That’s what the $2 billion Pimco bond ETF does. Right now, the fund is about 50 percent in mortgage-related debt, with 20 percent in U.S. Treasurys and about 25 percent in investment-grade corporate bonds. Previously, this fund has moved into emerging-market debt, short-duration credit instruments and other strategies to maximize yield and limit losses. For investors who want to leave the decisions to experts, BOND is a great choice in any environment.
Current yield: 3.4 percent
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8 Bond ETFs to Cope With Rising Interest Rates originally appeared on usnews.com
