Putting Bond ETF Dollars To Work

The first few days of the year have been marked by strong investor demand for ETFs, including U.S. bond ETFs.

So far, the demand seems centered on some of the larger, broader funds—funds like the iShares Core U.S. Aggregate Bond ETF (AGG) and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK). But if you listen to the pundits, some point out there’s too much duration risk in the Barclays Aggregate (ETFs like AGG) right now, with portfolio duration at a historical high of about 6.7 years. The longer the duration, the more sensitivity the portfolio to interest rate changes.

There are also those who say equity market strength should bode well for high-yield debt, but in 2017, it was funds like the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) that delivered the bigger gains relative to junk bond counterparts like JNK.

The chart below plots these two ETFs’ performance for the past 12 months. 

There seems to be no consensus when it comes to where to put your money to work in U.S. fixed income today. So we asked some ETF strategists for their views: What part of the bond market do you like best?

Marc Odo, director of investment solutions at Swan Global; Durango, Colorado

We’ve been bearish on bonds for quite some time. With yields being where they are, there's simply no way bonds can provide the levels of returns they’ve historically had over the last few decades. Historically, bonds did two things for you: They provided income and they protected your portfolio. You could have your cake and eat it too. These days, it's one or the other—and maybe neither.

Fixed income simply cannot perform its dual role of income and portfolio protection going forward, which is why our whole strategy is based upon hedging. That said, if I were to invest in fixed income, there are some things I would do and some things I wouldn't.

On the investment-grade side, I would keep to the short end of the curve. I have no desire to lock in a 2.50% rate for 10 years when the two-year rate is 2.00% and likely to rise.

I do think floating-rate instruments make sense; and I would stay away from high yield. [ETFs in these segments include the likes of the SPDR Bloomberg Barclays Investment Grade Floating Rate ETF (FLRN) versus the iShares iBoxx $ High Yield Corporate Bond ETF (HYG)]. The risk/reward trade-off just isn't there. The spreads are too low.

Even though people are talking about low default rates and the economy humming along fine for now, I've been hearing about the same kind of leveraging of the balance sheets and the "covenant-lite" issuance that was in vogue just before the global financial crisis of 2007-2008.

Scott Kubie, CIO of Carson Group; Omaha, Nebraska

The risk/reward trade-off in fixed income remains unattractive. As much of the slack is now out of the economy and the Fed’s balance sheet reduction is accelerating, we find puzzling that long-term bonds offer such a small rate premium to short-term bonds.

Inflation-linked bonds should be emphasized in most portfolios and short-term Treasuries provide better yields. [An example in ETF wrappers would be funds like the iShares TIPS Bond ETF (TIP) and the iShares 1-3 Year Treasury Bond ETF (SHY)]. We expect corporate bonds will outperform Treasuries in 2018, but the spread looks unattractive there as well.

We would rather allocate to low-risk short-term bonds and transfer any risk to international equity markets.

Stephen Blumenthal, CEO of CMG Capital Management Group; King of Prussia, Pennsylvania

The strongest momentum in fixed income continues to be in the high-yield space, and our clients own JNK [SPDR Bloomberg Barclays High Yield Bond ETF], but not without significant risk. Covenant quality has never been worse. In the recession cycle, I believe we’ll witness the single greatest buying opportunity in high-yield bonds in my more than 25 years trend-trading high yields as the next default wave will send bond prices south with little investor protection.

I see little risk of recession in the next six to nine months. Investors see risk in rising rates, as the Fed hikes, which will hurt high-quality bond ETFs like the iShares 20+ Year Treasury Bond ETF (TLT).

We see strong price trends in JNK and in the PowerShares Emerging Markets Sovereign Debt Portfolio (PCY). Investors are desperately searching for yield, and quantitative easing has forced investors into riskier asset classes. Step forward carefully and with a downside risk management game plan firmly in place, but let the “trend be your friend.”

Charts courtesy of StockCharts.com

There’s nothing easy about bond investing on the heels of what was a 30-year bond rally—and in the face of a potential yield curve inversion—while quantitative tightening gains a global scale.

The good news is that there are ETF choices a-plenty to implement any bond strategy you might want—more than 340 U.S.-listed fixed-income ETFs, to be exact. For a complete list, check out our Fixed Income ETF channel.

Contact Cinthia Murphy at [email protected]