Top Performing Fixed Income ETFs Of 2017

The bull market in bonds just won't quit. Every year in recent memory, the majority of analysts have predicted the end of the rally in bonds, and every year they've been proven wrong.

It's completely understandable why analysts have been so off the mark. You'd be hard pressed to find anyone who could have predicted that eight years into an economic expansion―with the U.S. jobless rate at 16-year lows, and stock prices at record highs— bonds would be doing so well and interest rates would be so low (bond prices and interest rates move inversely).

Especially this year―after the Federal Reserve hiked its benchmark federal funds rate three times in six months―any reasonable model would have forecasted lower bond prices. But of course, those models would be wrong.

Fixed-income securities across the board are up this year, including the widely followed U.S. 10-year Treasury yield, which saw its yield drop from 2.44% at the start of the year to 2.25% currently.

Likewise, fixed-income ETFs of all stripes are up this year. The largest of the bunch, the iShares Core U.S. Aggregate Bond ETF (AGG), has returned 2.9% so far in 2017. That's not a bad return for seven months, but there are several ETFs that have done even better, including a handful that are up double-digit percentages. Here we take a look at some of those.

Preferred Stock Recovery

Easily taking the mantle as the No. 1 fixed-income security of 2017 is the iShares International Preferred Stock ETF (IPFF), which is up 20% for the year.

Preferred stocks have characteristics of both equity and debt. They typically offer a sizable dividend that's safer than the dividends on 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.

Preferreds are essentially a way to capture higher yields than corporate bonds, but with higher risk if the company faces hard times.

As its name suggests, IPFF, with $82 million in assets and a 0.55% expense ratio, holds non-U.S. preferred stocks, the vast majority of which are issued by companies in Canada (80%), and to a lesser extent, the U.K. (10%).

The fund's distribution yield is currently 4.35%, meaning that most of this year's 20% gains for the ETF have come from price appreciation.

IPFF has a large exposure to Canadian bank and energy companies, which hurt the fund between mid-2014 and early 2016 when oil prices were crashing (the fund dropped nearly 50% from peak to trough). This year, that trend reversed, as energy prices stabilized.

Favorable Currency Movements

The next ETF on the top-performers list is another international fund, the iShares International High Yield Bond ETF (HYXU), with a 14.6% return. This ETF, with $67 million in assets and a 0.40% expense ratio, holds high-yield corporate bonds, primarily euro-denominated issues from Europe.

Most of the gains for the ETF came from price appreciation, as its distribution yield is only 1.35%. Moreover, most of that price appreciation came from the 11% rally in the euro against the U.S. dollar.

Indeed, the common thread shared by many of 2017's top-performing fixed-income ETFs is that they hold international bonds denominated in local currencies, something that's paid off in a year in which foreign currencies have advanced against the greenback.

The Cambria Sovereign Bond ETF (SOVB), up 12.5% this year, has benefited from that trend. It's an actively managed fund (with $10 million in assets and a 0.60% cost) that holds high-yield sovereign and quasi-sovereign bonds from around the world.

Top holdings for the fund currently include sovereign bonds from Brazil, China, Philippines and China.

Local-Currency EM Bond ETFs

Exposure to emerging market bonds has been a boon for SOVB this year, but it's not the only ETF that's ridden that wave. Four other ETFs on the top 10 list focus specifically on local-currency emerging market bonds.

The First Trust Emerging Markets Local Currency Bond ETF (FEMB), the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC), the iShares J.P. Morgan EM Local Currency Bond ETF (LEMB) and the SPDR Bloomberg Barclays Emerging Markets Local Bond ETF (EBND) all returned between 11% and 12% so far this year. Current distribution yields for the ETFs range from 5% to 6%.

All four of the ETFs hold local-currency emerging market bonds. When the dollar drops, as it's done this year, appreciating emerging market currencies add to the returns for these funds. That's in contrast to recent years, when the dollar has advanced, hurting local-currency emerging market bond ETFs.

Convertible Bond ETFs

Rounding out the top 10 performers list is a pair of convertible bond ETFs, the SPDR Bloomberg Barclays Convertible Securities ETF (CWB) and the iShares Convertible Bond ETF (ICVT), with gains of 13.2% and 12.6%, respectively.

Convertible bonds are bonds that can be exchanged for common stock or preferred stock. With stocks on a tear this year, CWB and ICVT have handily outperformed, even though they each yield only about 2.5%.

For a full list of this year's top-performing fixed-income ETFs, see the table below:

Top 10 Fixed-Income ETFs (excluding inverse/leveraged)

Data measures the year-to-date period through July 24, 2017

Contact Sumit Roy at [email protected]