When interest rates rise, bond investors tend to get itchy, because the values of their fixed-rate bond holdings are suddenly worth relatively less than the yields on newly-issued bond instruments.
Fortunately, certain fixed-income products potentially benefit from rising interest rates by investing in shorter-duration bonds and by employing interest rate swaps, convertible securities, floating rate bonds, and other alternative plays. The five U.S. bond exchange traded funds (ETFs) below exemplify these strategies.
- When interest rates rise, fixed-rate bondholders may bemoan the fact that their existing holdings offer lower yields than new issuances.
- Fixed income investing can become infinitely more complex when interest rates are rising.
(Note: All figures are current as of August 30, 2019.)
Direxion Daily 20-Year Treasury Bull 3X (TMF)
Direxion, a top manager of leveraged strategies, offers top performance in the bond category. By taking a three-times leveraged position on the 20-year Treasury, the fund strives to achieve high returns by replicating the performance of the ICE U.S. Treasury 20+ Year Bond Index. Instruments used to achieve its objective include the iShares 20+ Year Treasury Bond ETF, iShares 20+ Year Treasury Bond ETF SWAPs and cash.
- Price: $33.71
- Average volume: 2.5 million
- Net assets: $158.51 million
- Yield: 1.16%
- YTD return: 78.54%
- Expense ratio: 1.09%
The iShares Convertible Bond (ICVT)
ICVT offers investors a convertible bond strategy that seeks to track the holdings and return of the Bloomberg Barclays U.S. Convertible Cash Pay Bond > $250MM Index. The securities in the index can be converted to cash or equity, which consequently 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 but also invests in futures, options, and swaps. Top holdings in the fund include Microchip Technology, Intel, Dish Network, Verisign and Priceline.
- Price: $59.29
- Average volume: 51,250
- Net assets: $377.77 million
- Yield: 3.30%
- YTD return: 13.66%
- Expense ratio: 0.20%
The 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 that seeks to track the holdings and return of the Northern Trust Credit-Scored U.S. Long Corporate Bond Index, which uses a proprietary scoring method to select investment-grade bonds with a maturity of 10 years or more, that are issued by companies with at least $500 million in outstanding principal.
From that universe, the fund chooses debt securities based on factors like company management efficiency, profitability, and market solvency. Top holdings include Goldman Sachs, JPMorgan Chase, Abbvie Inc, ConocoPhillips, Verizon Communications, and Microsoft Corporation.
- Price: $58.47
- Average volume: 1,946
- Net assets: $19.51 million
- Yield: 3.90%
- YTD return: 23.07%
- Expense ratio: 0.22%
The 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, which includes long term investment-grade corporate bonds, and a high concentration in the industrials sector. More than 80% of the fund comprises bonds with a duration of at least 15 years. Top holdings include Anheuser-Busch, Wal-Mart, AT&T, and Verizon.
- Price: $30.68
- Average volume: 409,295
- Net assets: $577.93 million
- Yield: 4.01%
- YTD return: 24.49%
- Expense ratio: 0.07%
The 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 returns. Using an index replication strategy, the fund seeks to match the holdings and return of the MVIS U.S. Investment Grade Floating Rate Index, which includes investment-grade floating-rate bonds from corporate issuers. Top holdings include Goldman Sachs, Morgan Stanley, Citigroup, and Wells Fargo.
- Price: $25.21
- Average volume: 124,367
- Net assets: $529.58 million
- Yield: 3.11%
- YTD return: 3.91%
- Expense ratio: 0.14%
While bond ETFs can effectively mitigate general risk, the underlying investments can specifically suffer from credit risk, call risk, inflation risk, and liquidity risk.
The Bottom Line
Fixed income investing can become infinitely more complex when interest rates are rising. Bond ETFs offer strategies to help fixed income investors remain in positive territory, in these markets.