How To Pick The Right Bond ETFs

August 21, 2014

With so many choices in the realm of fixed-income ETFs, it helps to have a system for choosing them.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features John Eckstein, chief investment officer and director of research at Astor Investment Management.

This month we thought we would share one of our tools for our portfolio of fixed-income ETFs.

The two main risk factors in the fixed-income world are the duration—related to the maturity—and credit quality of the underlying instruments. These are not the only factors to consider, of course, but they do form a very useful framework for thinking about fixed-income investments.

The chart below is drawn from ETF.com’s excellent Analytics page. There are more than 200 U.S. fixed-income ETFs listed, so we need to do some pruning to make our chart legible and to do justice to our dual expectations that rates are likely to head higher next year and that the U.S. economy is likely to keep strengthening.

We start by focusing on larger ETFs; then we drop the leveraged and inverse ETFs; then we add in a few especially interesting smaller funds. We’ve also had to drop a few funds that are quite similar to other funds because of crowding in the chart below.

Fixed_Income_Risk_Reward

A Tour Of The Fixed-Income World

The chart lays out duration on the X axis and credit on the Y axis. It’s structured such that the highest-quality and shortest-duration funds—think Treasury bills—are at the lower left-hand corner.

Note that if you do research on other sites, you may find slightly different yields, credit and duration metrics. The size of the points reflects the dividend yield, which is also printed by the fund ticker. Note that only BBB and below are considered "investment grade."

As we tour through the fixed-income world, we will orient ourselves relative to AGG (in red on the chart), a common benchmark for the fixed-income world that is designed to reflect the total U.S. dollar investment-grade index.

If we demand low risk in terms of either credit or maturity, we will quickly land in a very-low-yield area of the chart, the lower left-hand corner with yields around zero percent. What happens to our risks as we search for yield?

 

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