Short-Duration Funds' Growing Appeal

January 20, 2015

Other Risks & Hidden Costs
While using these ETF products fulfills the need for better yield and lower interest-rate risk, short-duration investors may be losing sight of other risks. While seeking yield, they’ve increased exposure to credit-spread risk.
In deteriorating economic environments, widening corporate spreads over Treasurys will cause underperformance to other ETF products. Not to be taken lightly, the opportunity cost needs to be factored in as well. Lower-duration protection caps the gains of fixed-income securities when interest rates go lower. In the last few years, investors in the higher end of the yield curve have been rewarded for their risk.
Implicit costs such as the expense ratios for these funds need to be taken into consideration, especially in this low-rate environment. These ETF categories carry high administrative costs compared with their passive cohorts. Transaction costs are also an issue, as ETFs are exposed to market-price risk. The bid/ask spreads may be unfavorable in illiquid ETFs and become even bigger in times of market stress.
What The Future Holds
It is anybody’s guess if short-duration ETFs will continue growing in size or if they are a temporary fad. What has been proven is the high adaptation of ETFs to create new products and fill new niches. In the end, more choices benefit all investors.

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