The U.S. fixed-income market is bracing for some turbulence as investors head into autumn, as a shift in monetary policy begins to take shape.
[Sign up for stock news with our Invested newsletter.]
Recent movements in the yield curve, a critical financial indicator, have shown a notable change. Traditionally, when short-term yields like the two-year U.S. Treasury yield exceed those of long-term yields like the 10-year, it precedes the possibility of a recession.
However, this curve has recently “dis-inverted,” hinting at an uncertain economic outlook and expectations of interest rate reductions, which just came to fruition as the Federal Open Market Committee (FOMC) cut interest rates at its Sept. 18 meeting.
This marks the beginning of the first easing cycle in several years, prompted by lowered short-term rates, moderating inflation, and a reassessment of risk and opportunities in the bond market.
“We acknowledge risks to the economic outlook are higher than six months ago, but an imminent recession isn’t our base case,” says Jonathan Finkler, head of fixed-income services at Bartlett Wealth Management. While the September cut “won’t likely reinvigorate economic activity to any great degree, it’s an acknowledgement from the Federal Reserve that the time has come to begin the process of removing its restrictive monetary policy,” Finkler says.
As these shifts take place, it’s a crucial time for investors to review their fixed-income holdings to ensure they are optimally positioned for the changing economic landscape.
“Yields offered through investment-grade corporate and government bond securities have indeed been scaled back over the last year, but the income potential provided by some of these instruments is still trading at generous levels relative to the last 15 to 20 years,” says Robert Scrudato, director of options and income research at Global X ETFs.
In particular, some experts are cautiously optimistic that the rate-cutting cycle will provide tailwinds to fixed-income investments.
“A long-winded rate-cutting cycle could prove supportive to bond portfolios from a value perspective, particularly with duration exposures out toward the longer end of the curve,” Scrudato argues. “That said, with corporate earnings and GDP consistently outperforming expectations, the possibility that aggressive rate cutting would promote a resurgence of inflation is ever-present.”
Here are five great fixed-income mutual funds and exchange-traded funds (ETFs) to buy in 2024:
| Fund | Yield to Maturity | Expense Ratio |
| Vanguard Total Bond Market Index Fund Admiral Shares (ticker: VBTLX) | 4.4% | 0.05% |
| Vanguard Total Corporate Bond ETF (VTC) | 5.0% | 0.04% |
| Global X Intermediate-Term Treasury Ladder ETF (MLDR) | 3.8%* | 0.12% |
| Invesco Senior Loan ETF (BKLN) | 8.9% | 0.65% |
| Invesco AAA CLO Floating Rate Note ETF (ICLO) | 6.7%** | 0.20% |
*Yield shown is for the index, not the ETF, which is new and has not yet reported a yield.**30-day SEC yield.
Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX)
“The main benefit of bond funds for investors is convenience,” says Chris Tidmore, senior manager at Vanguard’s Investment Advisory Research Center. “Bond funds offer significant time savings over building and managing portfolios of individual bonds yourself and allow investors to build a broadly diversified bond portfolio with only a few funds.” A great example is VBTLX, which spans the total U.S. bond market and charges a minimal expense ratio of just 0.05% with a $3,000 minimum investment requirement.
This mutual fund tracks the Bloomberg U.S. Aggregate Float Adjusted Index, which holds more than 11,100 government, agency, mortgage-backed and investment-grade corporate bonds. Investors can currently expect an average 4.4% average yield to maturity, which is the theoretical total return expected if all of VBTLX’s current bonds were held until maturity. Contrasting this is a six-year average duration. All else being equal, a 100-basis-point cut in rates will cause VBTLX to gain 6% in net asset value (NAV).
Vanguard Total Corporate Bond ETF (VTC)
“Given the higher risks and costs associated with portfolios of individual bonds, and the time they take to manage, most investors are better served by low-cost mutual funds and ETFs,” Tidmore says. “This is particularly true in the case of municipal and corporate bonds, which are less liquid and harder to purchase than Treasury bonds.” For targeted exposure to a wide swath of investment-grade corporate bonds, Vanguard offers VTC at a 0.04% expense ratio and a price of about $79 per share.
This ETF uses a “fund of funds” structure, holding three other Vanguard ETFs tracking short-term, intermediate-term and long-term corporate bonds. In the aggregate, VTC holds more than 7,600 bonds with an average yield to maturity of 5% and a duration of seven years. The majority of bonds in this ETF are rated “A” and “BBB” as per its investment-grade mandate. However, income from this ETF is less tax-efficient, so investors should prioritize holding it in a tax-sheltered account like a Roth IRA.
Global X Intermediate-Term Treasury Ladder ETF (MLDR)
“Global X recently brought to market three fixed-income-oriented ETFs that make up its ‘Treasury Ladder’ ETF suite,” Scrudato says. “Gaining exposure to various portions of the Treasury yield curve by laddering equally weighted bond positions across multiple maturity dates and rolling exposures over time, the funds seek to mitigate interest rate volatility and reinvestment risk, while providing convenience and potential cost benefits through the ETF structure.”
Investors looking for a “Goldilocks” option in this lineup might prefer MLDR, which tracks the middle of the Treasury yield curve via the FTSE US Treasury 3-10 Years Laddered Bond Index. As a new ETF, detailed portfolio metrics are still unavailable. However, the index itself reported an average 3.8% yield to maturity and duration of 5.3 years. Along with the Global X Short-Term Treasury Ladder ETF (SLDR) and the Global X Long-Term Treasury Ladder ETF (LLDR), MLDR charges a 0.12% expense ratio.
Invesco Senior Loan ETF (BKLN)
“In our view, it is important for investors to consider alternatives in the fixed-income market that sit outside of a traditional core bond allocation,” argues Brian McMullen, senior fixed-income ETF strategist at Invesco. “The Bloomberg Aggregate Index only represents around 50% of the investable fixed-income market, and investors can potentially miss out on opportunities to diversify their portfolios and enhance income.” A viable alternative fixed-income ETF to consider is BKLN, which owns senior loans.
“Senior loans are below investment-grade credit quality but can potentially offer higher yields relative to core segments of fixed income, like Treasurys and investment-grade corporate bonds,” McMullen notes. “Another unique attribute of senior loans is their floating-rate coupon structure, which allows for less sensitivity to interest rate volatility relative to fixed-rate bonds.” BKLN currently pays a high 8.9% yield to maturity and charges a 0.65% expense ratio. The ETF pays monthly distributions.
Invesco AAA CLO Floating Rate Note ETF (ICLO)
“Collateralized loan obligations (CLOs) generate their cash flows from an underlying pool of securitized banks loans,” McMullen explains. “Their unique structure allows them to have built in cash flow waterfall protections for investors in the highest-rated tranches.” By combining multiple AAA-rated CLOs into an ETF, ICLO provides fixed-income investors with greater diversification and lower risk of default, while still passing along above-average income potential with a 6.7% 30-day SEC yield.
It’s crucial to distinguish CLOs from the collateralized debt obligations (CDOs) infamous for their role in the 2008 financial crisis. While both involve pooling various types of debt, CLOs largely contain corporate loans with first liens on an issuer’s assets, which results in higher recovery rates and lower loss rates. In contrast, CDOs often included riskier types of debt like subprime mortgages, which lacked sufficient default and recovery data that credit analysis could not assess and price properly.
[READ: How to Invest When Interest Rates Are Cut]
More from U.S. News
9 Highest Dividend-Paying Stocks in the S&P 500
9 of the Best Bond ETFs to Buy Now
Recession 2024: What to Watch and How to Prepare
5 Great Fixed-Income Funds to Buy Now originally appeared on usnews.com
Update 09/18/24: This story was previously published at an earlier date and has been updated with new information.
