Low interest rates are here to stay for the time being.
When the Federal Reserve cut interest rates to near zero earlier this year, yields fell across the board — most notably in short-duration bond funds, for which the Fed’s monetary policy often has the greatest influence. Ultra-low interest rates make it challenging to find yield, so investors need to be choosy, says Marc Pfeffer, chief investment officer at CLS Investments. Money that’s earmarked to be spent in one to two years should be kept in safe investments since people may not have time to recoup losses from volatile stocks. While yields in short-term bond funds are lower than they were at the beginning of the year, investors can still find some viable funds if they’re willing to take on some credit risk. Here are eight of the best short-term bond funds to consider.
Vanguard Short-Term Bond Index Fund (ticker: VBIRX)
When interest rates are so low, fees are critical, says Holmes Osborne, principal at Osborne Global Investors. That’s one reason to consider VBIRX for a short-term bond fund because it has an inexpensive annual expense ratio of 0.07%, or $7 for every $10,000 invested, and a yield of 1.89%. This fund tracks the Bloomberg Barclays U.S. 1-5 Year Government/Credit Float Adjusted Index. This index includes the non-securitized segments of the Bloomberg Barclays U.S Aggregate Bond Index, with one to five years left until maturity. The fund holds U.S. Treasurys, other government-related bonds and investment-grade corporate bonds. VBIRX takes less credit risk than other funds in a similar category, and that should make it less volatile.
FlexShares Ready Access Variable Income Fund (RAVI)
Investors who seek liquidity and capital preservation but also want income can look to RAVI. The fund targets higher yield while seeking to minimize volatility with its mix of mostly investment-grade corporate bonds. It holds mostly AA, A and BBB bonds with one to three years to maturity. Mark Shone, president of Shone Wealth Management, says one reason he recommends RAVI for clients is to complement the cash they have sitting in banks. “It’s part of what we call the cash-plus bucket,” he says, as RAVI lets him extend maturity and credit risk for clients who can accept a little more risk. “It’s a fund that sits in that little sweet spot between short duration and money market.”
Vanguard Short-Term Corporate Bond ETF (VCSH)
Steven Jon Kaplan, CEO at True Contrarian Investments, says VCSH is his favorite short-term bond fund for its low expense ratio of 0.05% and its longevity since the exchange-traded fund has been around for 11 years. “The primary investment objective is safety so that the companies selected are of the highest quality,” Kaplan says. “The total annualized returns tend to be between 3% and 4% over long time periods.” The fund tracks the Bloomberg Barclays U.S. 1-5 Year Corporate Bond Index. While the fund holds investment-grade bonds, there is some credit risk since nearly 90% of its holdings are rated either A or Baa. This is a large fund, with nearly $40 billion in assets, and it has a 12-month yield of 2.51%. Kaplan says investors should be aware a small risk to this fund comes if interest rates start to rise rapidly.
Channel Short Duration Income Fund (CPSIX)
Scott Jarred, CEO of JarredBunch, notes that investors seeking short-duration bond funds have limited offerings with interest rates so low. Jarred’s choice is CPSIX, an actively managed mutual fund from Channel Investment Partners. “Portfolio manager Matt Duch has a really good eye for what is going to happen and his track record from prior experiences will dictate that,” Jarred says. CPSIX has outperformed its category and the Bloomberg Barclays U.S. 1-3 Year Government/Credit Bond Index over a one-, three- and five-year time frame. The fund holds a mix of investment-grade corporate and government securities, and the bulk of the holdings are rated AAA or A. The fee is slightly high, at 0.9% annually, but its total return this year is about 5%.
Invesco BulletShares 2022 Corporate Bond ETF (BSCM)
For conservative portfolios, Daniel Milan, managing partner at Cornerstone Financial Services, says he is using a few types of ETFs to manage short-term investments. BSCM is part of the Invesco Bulletshares suite, which lets investors ladder funds with different maturity levels. Milan says he is using BSCM as a substitute for a traditional short-term duration fund. “We know it’s going to mature, which helps mitigate any risk of short-term-interest-rate volatility risk,” he says. It also has less credit risk because it is an investment-grade corporate bond fund. BSCM tracks a market-value-weighted, U.S. dollar-denominated, investment-grade corporate bond index. When the fund matures, it returns all capital to investors. BSCM comes with an expense ratio of 0.1%.
First Trust Low Duration Opportunities ETF (LMBS)
LMBS is an actively managed bond ETF that invests in several types of mortgage-backed securities that have a target duration of less than three years. The fund’s weighted average effective net duration is 1.57 years and it has a 12-month distribution rate of 2.33%. Milan says that as an actively managed fund, LMBS has a higher expense ratio than an index fund, at 0.67% — but Milan believes the extra cost is worth it. “If we want to mitigate against short-term-interest-rate volatility risk, having active management within the MBS sector, in the right situation, can be worth paying that little bit of extra for,” he says.
Janus Henderson Short Duration ETF (VNLA)
Pfeffer says he generally prefers to use actively managed bond funds in the short-term bond space for the chance to make higher returns versus index products. Although active ETFs have slightly higher costs than index ETFs, investors should “focus on the after-tax return rather than the expense ratio,” Pfeffer says. He likes the actively managed VNLA fund, which has the goal of outperforming the benchmark Libor three-month rate by holding a variety of fixed-income securities, with a duration of zero to two years as its managers look to take advantage of market inefficiencies. It costs 0.26% annually and is up nearly 3% year to date.
Fidelity Total Bond ETF (FBND)
FBND, also an actively managed bond ETF, is another favorite of Pfeffer’s. He points out that it has exposure to credit risk with its high-yield holdings — which can be up to 20% of its holdings — but that has helped the fund’s performance. FBND uses both rules-based sector allocation and active security selection as it seeks broad exposure to the U.S. dollar-denominated debt market. In addition to high yield, the fund includes a mix of U.S. Treasurys, mortgage-backed securities and U.S. dollar-denominated emerging-market debt. For an annual cost of 0.36%, it has a yield around 2.48% and a total return of nearly 8% this year. “This is another good fund that I’ve liked this year,” he says.
Eight short-term bond funds to consider:
— Vanguard Short-Term Bond Index Fund (VBIRX)
— FlexShares Ready Access Variable Income Fund (RAVI)
— Vanguard Short-Term Corporate Bond ETF (VCSH)
— Channel Short Duration Income Fund (CPSIX)
— Invesco BulletShares 2022 Corporate Bond ETF (BSCM)
— First Trust Low Duration Opportunities ETF (LMBS)
— Janus Henderson Short Duration ETF (VNLA)
— Fidelity Total Bond ETF (FBND)
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