Best and Worst Performing Bond ETFs in 3Q

RISR did the best, while iShares' GOVZ trailed the pack.

Long-term interest rates rose steadily throughout the third quarter, hitting the longest-duration exchange-traded funds the hardest, while interest-rate hedging ETFs and CLO, or collateral loan obligation, funds flourished.  

The FolioBeyond Alternative Income & Interest Rate Hedge ETF (RISR) was the best-performing bond ETF in the third quarter, returning 6.9% for the quarter, while the iShares 25+ Year Treasury STRIPS Bond ETF (GOVZ) was the worst performing, losing 21%. The best and worst performers were chosen based on their three-month total returns as of Sept. 28, according to etf.com data. Leveraged and inverse ETFs were excluded. 

Long-term interest rates, as measured by the yield on the 30-year Treasury, rose by 21% to 4.87% durig the third quarter. Because bond yields and prices move in opposite directions, this rise hit the longest-duration bond funds the hardest, which is why the worst-performers list is made up entirely of long-duration funds. The best-performer list was topped by RISR, which hedges against rising rates but also included two CLO funds, which rose as the yield curve moderated, indicating increasing belief in a “soft landing” for the U.S. economy.  

Best Performing Bond ETFs

Worst Performing Bond ETFs

Bond ETFs and the Yield Curve 

The yield curve refers to the relationship between bond duration and yield, and normally curves upward, with higher-duration bonds yielding more. That is because investors take on more risk by lending money over longer periods.  

The yield curve has been inverted all year, as measured by the difference between the 10-year and two-year bond yields. An inverted yield curve is when long-term interest rates exceed shorter-term ones. This usually occurs when investors expect a recession and subsequent rate cuts. As a result, investors then want to lock in higher rates for longer, increasing demand for longer-term bonds and pushing down yields. 

According to Federal Reserve data, the 10-year Treasury yield was about 0.6% lower than the two-year treasury yield at the beginning of the second quarter and widening to over 1% during quarter. The yield curve, however, began to normalize more during the third quarter, with the 10-year yield ending only 0.44% lower than the two-year by Sept. 28.  

This means investors are predicting rates will remain higher for longer, possibly because recession will prompt the Federal Reserve to lower them. This hits long-duration funds the hardest, and strip-bond funds like GOVZ have the longest duration of all, as they do not pay off at all until the bond matures. 

Soft Landing for CLOs 

The normalization of the yield curve implies that bond investors believe a recession is less likely, so assets hit hard by a recession have risen. Funds that hold collateralized loan obligations, loans usually to smaller companies with weaker credit tend to be hit hard by recessions, so as recession fears ebbed in the third quarter, CLO funds rose.  

Contact Gabe Alpert at [email protected]