A look at the chart below will give you an idea of how that move impacted the bonds in our sample set:
The Bond Investor’s Challenge
The trouble portfolio managers have had over the past few years has been to generate yield in a declining rate environment. Aside from levering up, the only other two ways to accomplish this are:
- taking on higher credit risk, or
- extending duration
Oftentimes, all three strategies—leverage; extra credit risk; and longer duration—will be employed to meet a specific yield mandate.
With interest rates still near historic lows, an investor’s return per unit of risk has declined meaningfully. As the chart below illustrates clearly with respect to the Barclays Agg, investors are accepting nearly three times the risk to achieve the same yield they could earn 20 years ago.
One way for fixed-income investors to prepare for this is by controlling for duration via target-maturity bond ETFs.
Target-Date Maturity ETFs
Both Guggenheim and iShares offer target-date bond ETFs that invest in investment-grade corporate bonds, high-yield bonds and municipal bonds. Investors get the liquidity, cost and diversification benefits of ETFs while knowing that their bond fund carries an “expiration date.”
This is in stark contrast to the perpetual nature of traditional fixed-income ETFs.
Bond ladders and barbells can easily be constructed using target-date ETFs. They can also help portfolio managers tilt a portfolio one way or another, either adding or subtracting duration from a core bond portfolio, depending on one’s view over the future direction of interest rates.
Guggenheim even offers a neat tool on its website for portfolio managers to easily model ETF portfolio characteristics—granted they use the BulletShares product. A link to this helpful tool can be found here.
Understanding the interest-rate sensitivity of one’s investment portfolio is important regardless of where interest rates are heading. With the Fed seemingly admittedly poised to initiate a rate-tightening cycle, it’s especially timely to know how one’s portfolio will react.
By taking advantage of the different ETFs and ETF provider tools available in the marketplace, professional and individual investors alike can more effectively manage interest-rate risk in their portfolios.
At the time of writing, Nottingham owned shares of AGG, BND, LQD, BSV, HYG as well of some BulletShares target-maturity bond funds. Nottingham Advisors is an ETF strategist that manages and advises on more than $1 billion in assets for advisors, institutions and individuals. Nottingham has been using ETFs since 2001 and currently offers five unique strategies with focuses on risk-based total return, current income and real return. To learn more, visit www.nottinghamadvisors.com or contact Nottingham directly at 716-633-3800. For all relevant disclosures, please go here.