The global financial markets are navigating through several uncertainties that could be addressed by investing in bond funds. U.S. presidential elections are due and markets can exhibit higher volatility. At the same time, a second wave of coronavirus infection can result in a prolonged economic slowdown.
Amidst these uncertainties, it’s important to ensure capital preservation. This would imply diversification to low beta stocks, bond funds and precious metals. Within the bond space, investors can consider exposure to government bonds as well as investment grade corporate bonds.
Interestingly, bonds have not been a laggard when it comes to returns as compared to equities, even as bonds have a significantly lower beta factor.
In the last 20 years, U.S. stocks provided an average annual return of 6.9%. For the same period, U.S. bonds provided an average annual return of 5.1%. On a long-term horizon, U.S. equities delivered average annual returns of 10.9% since 1971. U.S. bonds generated average annual returns of 7.3% during the same period.
Therefore, bond returns have been attractive besides the low risk factor. This makes bonds worth considering for the near term as well as for the long-term portfolio.
Let’s look at four bond funds that are attractive in these uncertain times.
- iShares U.S. Treasury Bond ETF (BATS:GOVT)
- iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD)
- Vanguard Emerging Markets Government Bond ETF (NASDAQ:VWOB)
- iShares TIPS Bond ETF (NYSEARCA:TIP)
Bond Funds: iShares U.S. Treasury Bond ETF (GOVT)
U.S. government bonds are potentially risk-free investments and the GOVT ETF is my top pick among bond funds. The exchange traded fund gives investors exposure to U.S. Treasuries ranging from one- to 30-year maturities.
The ETF has delivered returns of 8.06% for year-to-date. In addition, the ETF has a 12-month trailing yield of 1.47%. As bonds with negative yield continues to rise globally, the ETF is attractive.
Another important point to note is that the equity beta (calculated vs. S&P 500) is -0.12 for the ETF. If equity markets do correct in the foreseeable future, the GOVT ETF is likely to trend higher.
The Vanguard Long-Term Treasury ETF (NASDAQ:VGLT) is also interesting. However, the Vanguard ETF has an average bond maturity duration of 18.7 years. For the GOVT ETF, the average bond maturity duration is 6.9 years. This makes the GOVT ETF less sensitive to short-term interest rate fluctuations.
iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD)
Among bond funds, investors can consider exposure to ETFs that invest in investment grade corporate bonds. In my view, IG bonds are as safe as U.S. government bonds. In addition, the 12-month trailing yield for IG bond ETFs is higher as compared to government bonds ETFs.
The LQD ETF is worth considering for portfolio diversification. Some of the top holdings of the ETF includes bonds issued by Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM) and Apple (NASDAQ:AAPL), among others. In terms of credit quality, the ETF gives 41.39% exposure to A rate bonds and 47.12% exposure to BBB rated bonds.
The LQD ETF has delivered 7.8% returns on a year-to-date basis. In addition, the ETF has a 12-month trailing yield of 2.88%. In a low interest rate environment, the yield is attractive.
From the perspective of creating a defensive portfolio, LQD ETF has a beta of 0.21 as compared to the S&P 500 index. This implies low volatility even if the volatility index (VIX) surges for equity markets.
Overall, LQD ETF is a good option for investors considering exposure to corporate bonds.
Vanguard Emerging Markets Government Bond ETF (VWOB)
Besides exposure to government and corporate bond funds in the United States, investors also need to look at emerging market bonds.
One of the key factors to consider emerging market bond funds is a higher yield to maturity. As inflation accelerates in the coming years, it’s important to have asset classes that deliver higher returns.
To put things into perspective, the VWOB ETF has a YTM of 4.3%. In addition, in the last five years, the average annual return (based on NAV) has been 6.04%.
Further, the Bloomberg Barclays USD Emerging Markets Government RIC Capped Index has a beta of 1.02. Therefore, emerging market government bonds are also appropriate for a defensive portfolio.
Another fund that deserves a mention here is the iShares J.P. Morgan USD Emerging Markets Bond ETF (NASDAQ:EMB). The fund also has an attractive 12-month trailing yield of 4.13%.
However, the expense ratio for EMB ETF is 0.39% while the VWOB ETF has a lower expense ratio of 0.25%.
iShares TIPS Bond ETF (TIP)
Billionaire hedge fund manager Stanley Druckenmiller recently warned that inflation can hit 10% in the coming years. Even if inflation is around 5%, it makes sense to consider some exposure to the Treasury’s inflation-protected securities (TIPS).
The TIP ETF offers exposure to TIPS, bonds issued by the U.S. government. Given the concerns on inflation, the ETF is worth holding. At the same time, the ETF is not attractive from a yield perspective. A big exposure to the TIP ETF can be avoided.
The reason for low yield is a low level of volatility. The TIP ETF has a beta of 0.07 as compared to the S&P 500. However, so far this year, the ETF has moved higher by 9.2%.
On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modeling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.