With U.S. stocks on track for one of their largest annual gains on record, it’s easy to forget how well fixed income has done. The iShares Core U.S. Aggregate Bond ETF (AGG) is up 8.4% this year, the biggest return on record for the 16-year-old fund, which some consider a benchmark for bond ETFs.
Indeed, it was a monumental year for fixed income in many ways. Fueled by the relentless U.S.-China trade war, concerns about the health of the global economy sent bonds around the world surging. At one point, $17 trillion worth of global bonds were trading with yields below zero (bond prices and yields move inversely).
Race To Zero?
The negative-yield fever never reached U.S. shores, but even rates here probed all-time lows. The 30-year Treasury yield touched 1.9%, breaking below its previous all-time low of 2.09%, set in 2016. Meanwhile, at 1.43%, the U.S. 10-year Treasury yield got close, but never managed to break below 2016’s all-time low of 1.32%.
Yields have since rebounded modestly—the 10-year is currently around 1.93% and the 30-year is at 2.36%—but after three Fed rate cuts, there is little impetus for interest rates to spike dramatically higher.
The U.S. Central Bank has gone as far as to say that the threshold for moving on rates is very high—a sustained increase in inflation above its 2% target or a significant deterioration in economic fundamentals. That’s a high bar; thus the widespread expectation that rates in 2020 won’t be moving much at all.
Still, investors would be well-served to expect the unexpected. After all, it was nearly this exact time last year that the Fed made its fourth interest rate increase of 2018, and projected even more hikes in 2019. That forecast, of course, turned out to be utterly wrong. But it’s a great example of how difficult it is to forecast even a few months into the future.
Best-Performing Fixed Income ETFs Of 2019 (ex. leveraged/inverse)
Data measures total returns for the year-to-date period through Dec. 18.
Price Appreciation Over Yield
In a year in which AGG rose more than 8%, it’s not surprising that other fixed income ETFs have performed even better. In general, price appreciation was a much more important factor than yield in 2019, and the ETFs that held the most interest-rate-sensitive fixed income securities tended to perform the best.
Long-term bond ETFs are the biggest winners of 2019, with double-digit returns across the board. Long-term bond ETFs are usually much more interest-rate-sensitive than their shorter-term counterparts. Thus, a big move down in rates results in outsized price increases (and vice versa).
The popular iShares 20+ Year Treasury Bond ETF (TLT) is up 15% year to date, but others like the FlexShares Credit-Scored US Long Corporate Bond Index Fund (LKOR), the Vanguard Long-Term Corporate Bond ETF (VCLT), the SPDR Portfolio Long Term Corporate Bond ETF (SPLB), the iShares Long-Term Corporate Bond ETF (IGLB) and the PIMCO 25+ Year Zero Coupon US Treasury Index ETF (ZROZ) are up more—22% to 24%.
Preferred & Convertible ETFs Rise
Another group of fixed income ETFs to do well this year target preferred stock and convertible bonds. The First Trust SSI Strategic Convertible Securities ETF (FCVT), the SPDR Bloomberg Barclays Convertible Securities ETF (CWB) and the InfraCap REIT Preferred ETF (PFFR) are each up 20% or more this year.
Preferred stocks have characteristics of both equity and debt. They typically offer a sizable dividend that's safer than the dividends of a company's common stock, but not as safe as the interest payments on a company's bonds. Additionally, preferred stock can sometimes be converted into common stock.
Preferred stock ETFs are essentially a way to capture higher yields than corporate bonds, but with higher risk if the company faces hard times.
Meanwhile, convertible securities are typically bonds that can be exchanged for common stock or preferred stock. Convertible securities usually have lower yields than their vanilla counterparts, but their advantage is that they can be converted into equity at a specified price. That allows investors in convertible securities to share in a stock’s upside, while limiting downside if things go wrong. With stocks swinging upward in 2019, convertibles have rallied in tandem.
While ETFs holding long-duration bonds, convertible securities and preferred stocks make up the majority of the best-performing fixed income funds, there are a handful of products from other segments on the list too.
The VanEck Vectors CEF Municipal Income ETF (XMPT), which is up 20% this year, provides a twist to muni exposure by targeting closed-end funds that hold municipal bonds.
Another fund from VanEck, the VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL), is up 18% year to date. ANGL holds corporate bonds that have been recently downgraded from investment grade to junk—essentially, the highest-rated junk bonds on the market.
Finally, the JPMorgan USD Emerging Markets Sovereign Bond ETF (JPMB), which tracks emerging market dollar-denominated sovereign bonds, raced 17.5% higher this year as investors grew somewhat more optimistic about the economic prospects in developing countries.