5 Bond ETFs For A Rate-Proof Portfolio

Treasury yields have been on the rise in recent weeks on growing riskier appetite, expectations of tightening policies and improving economic fundamentals. Notably, 10-year yields jumped to 2.428% — the highest level since Mar 31.

Inside The Surge

Speculation is rife that the new Fed Chair will follow aggressive monetary policy tightening in 2018. Additionally, the Senate’s passage of the $4.1 trillion budget paves the way for tax cuts. This is putting further pressure on the bond market, pushing yields higher.

Rounds of upbeat data also led to a spike in yields. Manufacturing activity, as measured by the Institute for Supply Management, reached a 13-year high in September while non-manufacturing activity or the service sector expanded to the highest level since Aug 2005. Additionally, auto sales strongly rebounded in September posting the best month of the year, following the eighth consecutive month of decline. Consumer confidence soared to highest level since 2004 in early October, per the preliminary University of Michigan reading.

Moreover, the buzz that European Central Bank will scale back its €60 billion in monthly bond purchases in its meeting on Thursday and risk-on trade have also contributed to the increase in yields.

Given improving fundamentals, an increase in rates seems justified. As rates rise, bond investors might experience heavy losses given that bond prices and yields have an inverse relationship. While this is true, there are still several compelling choices in the fixed-income ETF world that could protect investors from rising rates. Below we highlight five bond ETFs that could be great picks in the rising rate environment.

Floating Rate ETFs

Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared with traditional bonds. As such, unlike fixed coupon bonds, these will not lose value when the rates go up. Hence, it protects investors from capital erosion in a rising rate environment.

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