Why Fixed Income Investments Are Back

After a challenging period marked by rising interest rates and declining bond prices, the fixed income landscape is evolving, in part thanks to ETF innovation.  

From its all-time high price in 2020, the bond market proxy iShares Core U.S. Aggregate Bond ETF (AGG) fell 25% to its lowest point in 2023, as the Federal Reserve aggressively raised its key interest rate to fight off the worst inflation in 40 years. 

The higher rates led to attractive yields for newly issued Treasury securities and short-term bond ETFs. Opportunistic investors bought shares of longer-dated bond ETFs like the iShares 20+ Treasury Bond ETF (TLT) expecting falling rates and price appreciation in 2024. TLT’s net inflows topped $10 billion year-to-date through August 16. 

As the investment landscape evolves, fixed income exchange-traded funds have become increasingly sophisticated, catering to a wide array of investor preferences and risk tolerances. 

What Are Fixed Income Investments?

Fixed-income investments provide regular, fixed payments of interest or dividends to investors over a specified period, along with the return of the principal amount at maturity. These investments are typically seen as lower risk compared to equities and can offer a predictable income stream, making them popular among conservative investors, retirees, or those looking to balance a more volatile portfolio.  

Common Types of Fixed Income Investments

• Government bonds: Issued by national government entities, such as the U.S. Treasury, these securities are considered safe since they are backed by the government's credit. Other Treasury securities include Treasury bills and Treasury notes, which have shorter maturities. 
• Municipal bonds: Issued by state or local governments to fund public projects, interest earned on these debt securities issued by state, county, and local governments are often tax-exempt at the federal level. 
• Corporate bonds: Issued by corporations to raise capital, these bonds generally offer higher yields than government bonds but may also come with higher risk. 
• High-yield bonds (junk bonds): These are corporate bonds with lower credit ratings, offering higher interest rates to compensate for higher risk. 
• Certificates of deposit (CDs): Issued by banks and credit unions, CDs offer a fixed interest rate for a specified term. They are insured up to certain limits by government agencies, making them very safe. 
• Preferred stock: This is a type of equity that pays dividends at a fixed rate before common stock dividends are paid. Preferred stocks typically don’t have voting rights but are considered more stable than common stocks. 
• Money market instruments: Short-term debt instruments such as Treasury bills, commercial paper, and certificates of deposit, these low-risk, highly liquid securities typically have maturities of less than one year. 
• Bond funds: These are mutual funds or exchange-traded funds that invest in a diversified portfolio of bonds. They offer diversification and professional management but do not guarantee the return of principal like individual bonds. 

Biggest Trends in Fixed Income ETFs in 2024

The fixed income ETF landscape is dynamic, and several trends have emerged in 2024: 

• Short-duration focus: As investors grapple with interest rate uncertainties, short-term and ultra-short-term bond ETFs have gained popularity. These offer lower interest rate risk and higher yields compared to long-term bond ETFs in 2024. 
• Economic uncertainty: Concerns about potential economic slowdowns or recessions have prompted investors to seek the relative stability and potential price appreciation of fixed income assets as a portfolio hedge. 
• Maturity of bull market: The prolonged equity bull market has increased investor awareness of the importance of diversification, leading to a greater allocation to fixed income. 
• ETF innovation: The proliferation of fixed income ETFs has made it easier for investors to access this asset class with lower minimum investment requirements. 
• Active management rise: While passive fixed income ETFs remain dominant, there's a growing interest in active management strategies. These ETFs aim to outperform benchmarks by utilizing manager expertise.  
• Municipal bonds: With potential tax advantages, municipal bond ETFs have gained traction, especially in higher tax brackets. 
• Emerging markets debt: As global economies recover, emerging market debt ETFs are offering opportunities for income and diversification. 

Investors should note that these trends are expected to evolve as economic and market conditions change.