Bond exchange-traded funds have become a hot topic once again as fixed-income investors are set to contend with a myriad of risks and opportunities through the remainder of 2015.
While bond yields are now off their lows for the year, and many funds now offering a more attractive entry point, there are still important criteria to consider in the areas of credit quality, duration and sector exposure. This becomes even more critical when the prospect of a Federal Reserve rate hike has the potential to significantly alter the landscape that everyone has become accustomed to over the last five years.
There is now over $50 billion in total combined assets invested in the iShares Barclays Aggregate Bond Fund ETF (NYSEARCA:AGG) and Vanguard Total Bond Market ETF (NYSEARCA:BND). Passive indexes of this nature, which are designed to encompass a wide swath of U.S. denominated bonds, are highly susceptible to interest rate fluctuations based on overexposure to Treasury and investment grade corporate debt.
In addition, while very high in underlying credit quality, these ETFs have seen their yields fall well below 2% as bond prices rose significantly last year.
To address these concerns, two new ETFs are coming to market that may offer unique ways to balance these risks while still remaining highly diversified.
This week, BlackRock is set to debut the iShares Fixed Income Balanced Risk ETF (NYSEARCA:INC), which is designed to use a smart beta approach in its underlying index construction methodology.
Rather than the traditional model of market capitalization weightings, the iShares Fixed Income Balanced Risk ETF will incorporate a 50/50 balance of credit and interest rate risk through higher allocations to corporate bonds. INC will also feature positions in U.S. Treasury futures to balance the interest rate risk of the total portfolio according to the underlying holdings.
While it’s too early to know how INC will perform under various interest rate and credit events, it appears the iShares Fixed Income Balanced Risk ETF will be far more balanced in its primary risk categories, which should in turn create a lower volatility position with the potential for higher yield than an aggregate index.
Another highly coveted debut this week will be the SPDR DoubleLine Total Return Tactical ETF (NYSEARCA:TOTL). TOTL is the first actively managed ETF that is sub-advised by Jeffrey Gundlach, one of the top fixed-income mutual fund managers of the last decade.
The TOTL strategy will be a mix of assets that include government issues, high yield, investment grade corporate and foreign debt from around the globe. The active designation gives the fund manager more flexibility to select areas of the market that he feels will outperform rather than follow a traditional asset allocation course.
The debut of the renowned Pimco Total Return ETF (NYSEARCA:BOND) in 2012 was one of the most successful active ETF launches in recent years and TOTL will likely be compared to this established brand. However, Gundlach has been known to depart from conventional views on interest rates and credit metrics, which is why this ETF may find its own niche that evolves over time.
Both new ETFs will give investors an additional tool in their arsenals that may prove to be worthy of consideration given the likelihood of changing dynamics in the bond market over the next several years. While there are also a variety of interest-rate hedged ETFs and other exotic strategies, these funds will still strive to relay a balanced and appropriate mix of assets for income investors to savor.
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