ETFs To Avoid Rate Surprises

July 18, 2013

The ETF market is full of problem-solving gems, even if they’re hard to find.

From May 1, 2013 to July 5, 2013, the yield on 10-year Treasury bonds jumped from a paltry 1.66 percent to 2.75 percent. While many have been expecting rates to rise as a result of all the quantitative easing, I admit the recent spike caught me a bit off guard.

The snail’s pace of improving economic conditions and the constant double-speak from the Fed had put me in a bit of a lull. Not anymore.

In the past, I wrote about different options for curtailing interest-rate risk with bond ETFs. Bank loans, floating rate notes, active strategies and soon-to-be-closed target-date funds have all made the rounds. After a rate jump of more than 1 percentage point in just two months, I decided to look back and see which of these strategies fared best.

I was a bit surprise to find that none of the previously mentioned options fared as well as an often-overlooked type of ETFs that I have only mentioned in passing before: variable rate demand obligations (VRDOs).

VRDOs are municipal bonds with resetting interest rates. These bonds typically have long-dated maturities, but interest rates reset on a daily, weekly or monthly basis, and investors have the option to put the bonds back at par.

Two funds target the space: the PowerShares VRDO Tax-Free Weekly Portfolio (NYSEArca: PVI) and the SPDR Nuveen S&P VRDO Municipal Bond ETF (NYSEARca: VRD). Both were part of a select group that eked out small gains at a time when almost all the other strategies posted losses.

Of the two funds, PowerShares’ PVI sports a higher expense ratio (25 basis points versus VRD’s 20 basis point), but as the first to market, has remained the preferred choice for investors. VRD has accumulated almost $225 million in assets under management and more than $3 million in average daily volume.

The fact that these funds performed exactly as billed wasn’t that shocking. However, the fact that they were the best-performing funds among the short- and ultra-short-term bond ETFs was definitely a bit of a surprise.

Since the short end of the curve remained virtually unchanged during the time 10-year Treasurys shot up, duration differences between these funds and some of their short-dated competitors shouldn’t have played much of a role in performance. Still, having the shortest durations across all fixed-income ETFs didn’t hurt their cause.


Find your next ETF

Reset All