Fixed Income ETFs Still Outperforming

Bonds are still beating stocks in 2020, even after a strong rally in the latter.

sumit
|
Senior ETF Analyst
|
Reviewed by: Sumit Roy
,
Edited by: Sumit Roy

There is a relentless bid under fixed income ETFs. Even accounting for the stunning rally in U.S. stocks since the March lows, it’s bonds and other fixed income securities that are outperforming this year—and attracting the largest inflows.

Fixed income ETFs have pulled in more than $74 billion of fresh cash so far in 2020, ahead of the $70 billion that has headed for U.S. equity ETFs.

It’s a neck-and-neck race, the winner of which may not be clear until the end of the year. In 2019, U.S. fixed income ETFs just barely edged past U.S. equity ETFs, gathering $135.4 billion in cash, compared with $130.2 billion for stock funds.

Fed Backstop

One advantage that fixed income ETFs have is steady purchases by the biggest buyer in the world, the Federal Reserve. Last week, the central bank pledged to keep purchasing Treasuries and mortgage-backed securities at a rate of at least $80 billion and $40 billion per month, respectively.

At the same time, Fed officials projected that they would keep the benchmark federal funds rate near zero through the end of 2022, or 2 1/2 years.

Those dovish moves by the central bank pushed benchmark Treasury rates down into their recent trading ranges, after a brief foray to the upside following a surprisingly strong jobs report for May. The benchmark 10-year Treasury bond yield was last trading around 0.72%, while the 30-year Treasury yield was trading around 1.46%.

US 10-Year Treasury Yield

 

Those rates are up from the record lows set earlier this year, but are still extremely low by historical standards.

ETFs tracking Treasuries have performed strongly in 2020, flying in the face of earlier calls that the bond bull market was over (bond prices and yields move inversely).

The iShares 7-10 Year Treasury Bond ETF (IEF) and the iShares 20+ Year Treasury Bond ETF (TLT) gained 10.7% and 20.7%, respectively, on a year-to-date basis.

Meanwhile, the largest fixed income exchange-traded fund, the $74 billion iShares Core U.S. Aggregate Bond ETF (AGG), which holds about 38% of its portfolio in Treasuries and another 16% in MBS, has returned 6.1% year to date.

YTD Returns For IEF, TLT, AGG

Credit Support

The Fed’s support for fixed income markets hasn’t stopped with Treasuries. That relentless bid has also extended to corporate bonds, primarily investment grade, but also high yield.

Under its Primary Market Corporate Credit Facility (PMCCF) and its Secondary Market Corporate Credit Facility (SMCCF), the Federal Reserve took the unprecedented step of offering to directly purchase corporate bonds in an effort to provide liquidity to corporate borrowers and narrow credit spreads.

The PMCCF, which will purchase initial bond offerings, isn’t yet operational. But the SMCCF, which buys bonds and bond exchange-traded funds on secondary markets, has already scooped up $5.5 billion worth of ETFs.

Those funds include the iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD), the Vanguard Intermediate-Term Corporate Bond ETF (VCIT) and the Vanguard Short-Term Corporate Bond ETF (VCSH).

Fed Also Buying Junk Bond ETFs

The Fed’s purchases also include funds that hold lower-rated junk bonds, such as the iShares iBoxx USD High Yield Corporate Bond ETF (HYG) and the VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL).

Though the Fed’s firepower is immense—the two corporate credit facilities can buy up to $750 billion worth of bonds—purchases by the central bank have been modest so far. Nevertheless, just the idea that the Fed is there to backstop the markets has worked to restore confidence and narrow credit spreads.

Corporations have managed to raise hundreds of billions of dollars at relatively low interest rates, while spreads for both investment-grade and high-yield debt have dropped significantly.

In fact, LQD hit an all-time intraday high on Monday, equaling a 6.2% return for the year. The riskier HYG is still down 3.2% in the same period, but that’s still slightly better than the 4.2% loss for the S&P 500.

YTD Returns For LQD, HYG, ANGL

Aid For Municipalities

A third area of the debt markets that the Fed has supported quite aggressively is the municipal bond market. The central bank agreed to purchase up to $500 billion of short-term municipal notes directly from issuers, helping cash-strapped state and local governments at a time when their tax revenues have been crushed due to coronavirus-related shutdowns.

The facility, which bought debt from the state of Illinois earlier this month, has also provided a shot in the arm to muni bond ETFs. The three largest ETFs in the space, the iShares National Muni Bond ETF (MUB), the SPDR Nuveen Bloomberg Barclays Short Term Municipal Bond ETF (SHM) and the SPDR Nuveen Bloomberg Barclays Municipal Bond ETF (TFI), are each up more than 2% on a year-to-date basis.

The VanEck Vectors High-Yield Municipal Index ETF (HYD), which holds lower quality issues, hasn’t fared as well. It’s down 7.3% in the same period.

While the Municipal Liquidity Facility helps plug a deep hole in municipal governments’ budgets, many say that direct aid to state and local governments from the federal government will be needed to truly shore up their finances.  

YTD Returns For MUB, SHM, HYD

Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2

 

 

 

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.