Financial advisers long have been using bonds as a tool to plan specific needs. A bond that reaches maturity on a known date can be used to match a cash flow need at about the same time. Another tool used by the profession is to purchase bonds of different maturity dates to capture a higher average yield than what is available from a bond that meets a specific maturity date.
Fixed income ETFs hold bonds of a certain maturity range. By holding ETFs that have bonds with a known lifespan, you can capture an average yield of bonds that is higher than what’s offered by a short-term bond.
The iShares Barclays 1-3 Year Treasury Bond Fund (NYSE:SHY) was established on July 22, 2002. SHY maintains a portfolio of short-term bonds and seeks to maintain an average maturity of one to three years at all times. The current average maturity is 1.81 years. This short-term strategy has posted the following returns as of Aug. 31, 2011.
- 1 month: 0.34%
- 3 months: 0.63%
- YTD: 1.41%
- 1 year: 1.38%
- 3 years: 2.54%
- 5 years: 3.85%
The declining returns history reflects the overall rates paid on bonds. But, unlike a bond, the future price of a share of SHY is not known today.
Staying in the same family, the iShares Barclays 3-7 Year Treasury Bond Fund (NYSE:IEI) was established on Jan. 2, 2007. IEI follows a similar pattern as SHY but holds bonds that have an average maturity of 4.78 years. Because IEI holds bonds with a longer maturity, it will pay a higher dividend thanks to the collected interest. The returns for this strategy are as of Aug. 31, 2011.
- 1 month: 1.83%
- 3 months: 3.74%
- YTD: 7%
- 1 year: 4.91%
- 3 years: 6.59%
IEI has delivered a better series of returns. Keep in mind that the YTD return is more attuned to the recent rise in bond prices resulting from investors seeking a safe haven for money. During such events, bonds with longer maturities will experience a greater rise in value than a shorter-term bond. The same unknown future price risk remains.
Going further, the iShares Barclays 7-10 Year Treasury Bond Fund (NYSE:IEF) was established on July 22, 2002. IEF applies the same method but holds bonds that have an average maturity of 8.61 years. This segment of bonds offers both greater risk and greater volatility in the prices of the underlying holdings than the previous two funds discussed. The returns as of Aug. 31, 2011 are listed below.
- 1 months: 4.65%
- 3 months: 7.42%
- YTD: 11.72%
- 1 years: 6.91%
- 3 years: 8.58%
- 5 years: 8.62%
IEF performance is in line with the expectation that bonds with greater maturities offer better yields. The YTD value is based on how this group of bonds changed during the recent flight to quality. Because of the uncertainty of future values, IEF might not make the best choice of vehicle to use to meet a long-term defined financial goal.
Holding various fixed income ETFs lets investors shift the overall holdings by rebalancing the split between these to capture better yields or control average maturities. This gives the investor better control than purchasing a bond mutual fund, where you just get quarterly updates on the holdings.
Jeffrey L. Stouffer is the principal of Mercantile Capital Group, a Herndon, Va.-based introducing broker registered with the CFTC and a member of the National Futures Association. He can be reached at firstname.lastname@example.org. He does not have any direct or indirect holdings in the aforementioned ETFs.