A period of rising interest rates is always an interesting time for bonds and bond exchange-traded funds (ETFs). In a rising rate environment, the value of existing bond holdings with fixed rates is at higher risk. Meanwhile, yields on new issuances are rising.
In a rising rate environment, such as is expected for the U.S. in 2018, a few considerations can help to mitigate risks with greater potential for gain. Looking to some alternative management styles in the bond category can be beneficial when rates could potentially rise. Strategies using interest rate swaps, convertible securities or floating rate bonds can be utilized for investment selection. Generally, investors can also look to shorter duration bonds for risk management in a rising rate environment. Exchange-traded funds (ETFs) managed to these strategies allow investors to leave the risk management to professionals while also achieving the advantages of diversification. (See also: Bond ETFs: A Viable Alternative.)
Below we have chosen five U.S. bond ETFs for 2018. Funds were chosen based on 2017 performance and market position. All figures are current as of December 26, 2017.
Direxion Daily 20-Year Treasury Bull 3X (TMF)
Direxion is a top manager of leveraged strategies and this fund offers top performance in the bond category. Year-to-date (YTD) through December 26, 2017, the fund has a return of 16.96%.
This Fund takes a three times leveraged position on the 20-year Treasury. It achieves the return by replicating with leverage, the performance of the ICE U.S. Treasury 20+ Year Bond Index. Instruments used to achieve the objective include the iShares 20+ Year Treasury Bond ETF, iShares 20+ Year Treasury Bond ETF SWAPs and cash.
- Price: $21.39
- Avg. Volume: 80,130
- Net Assets: $95.4 million
- Yield: 0.09%
- YTD Return: 16.96%
- Expense Ratio: 1.08%
iShares Convertible Bond (ICVT)
ICVT offers investors a convertible bond strategy. This fund seeks to track the holdings and return of the Bloomberg Barclays U.S. Convertible Cash Pay Bond > $250MM Index. Securities in the Index can be converted to cash or equity which makes their trading price less sensitive to interest rate changes. The fund aims to keep a minimum of 90% of its assets in securities from the underlying index, it also invests in futures, options and swaps.
In 2017, the iShares Convertible Bond ETF has a return of 16.41% through December 26. Top holdings in the fund include Microchip Technology, Intel, Dish Network, Verisign and Priceline.
- Price: $55.14
- Avg. Volume: 1,237
- Net Assets: $361.4 million
- Yield: 2.20%
- YTD Return: 16.41%
- Expense Ratio: 0.20%
FlexShares Credit-Scored U.S. Long Corporate Bond Index Fund (LKOR)
The FlexShares Credit-Scored U.S. Long Corporate Bond Index Fund offers investors a customized bond portfolio with top performance. This Fund seeks to track the holdings and return of the Northern Trust Credit-Scored U.S. Long Corporate Bond Index. This index uses a proprietary scoring method to select companies. Bonds must be investment-grade with a maturity of 10 years or more and be issued from companies with $500 million or more in outstanding principal. From that universe it then chooses debt securities based on factors such as a company’s management efficiency, profitability and market solvency.
In 2017, LKOR had a YTD return of 11.70%. Top holdings in the Fund include Goldman Sachs, JPMorgan Chase, Abbvie Inc, Conocophillips, Verizon Communications and Microsoft Corporation.
- Price: $54.08
- Avg. Volume: 821
- Net Assets: $18.9 million
- Yield: 4.80%
- YTD Return: 11.70%
- Expense Ratio: 0.22%
SPDR Portfolio Long Term Corporate Bond ETF (SPLB)
The SPDR Portfolio Long Term Corporate Bond ETF is issued by State Street SPDR and offers investors an investment option indexed to the Bloomberg Barclays Long U.S. Corporate Index. The Index includes long term investment grade corporate bonds with over 80% of the fund reporting a duration of greater than 15 years. The Fund is highly concentrated in industrial bonds which have positively influenced the performance of the Fund.
In 2017, SPLB had a YTD return of 10.36% through December 26. Top holdings in the Fund include Anheuser-Busch, Wal-Mart, AT&T and Verizon.
- Price: $28.36
- Avg. Volume: 13,409
- Net Assets: $246.3 million
- Yield: 4.10%
- YTD Return: 10.36%
- Expense Ratio: 0.07%
VanEck Vectors Investment Grade Floating Rate ETF (FLTR)
The VanEck Vectors Investment Grade Floating Rate ETF offers conservative investors a floating rate bond portfolio with steady return. The Fund uses an index replication strategy. It seeks to match the holdings and return of the MVIS U.S. Investment Grade Floating Rate Index. This index includes investment grade floating rate bonds from corporate issuers.
In 2017, the Fund returned 2.64%. Top holdings in the Fund included Goldman Sachs, Morgan Stanley, Citigroup and Wells Fargo.
- Price: $25.27
- Avg. Volume: 18,532
- Net Assets: $232.5 million
- Yield: 1.60%
- YTD Return: 2.64%
- Expense Ratio: 0.14%
The Bottom Line
Bond investment decisions can sometimes be more complex when interest rates are rising. By investing in an ETF, you get the wisdom of a money manager to help you. These five bond ETFs offer a range of options to support an investor’s conservative interests while still offering relatively substantial returns and an income component.