As a new earnings season is approaching, many investors wonder if the recent wobbly price action in equity markets could continue into April. Therefore, today we are introducing a bond exchange-traded fund (ETFs) that might help diversify portfolios as we get ready to welcome a new quarter.
ETFs can hold different types of fixed-income securities, like Treasuries, sovereign bonds, municipal bonds, corporate bonds and junk bonds.
In addition, ETFs with a hybrid structure, could include equities and other asset classes (like commodities or REITs) as well as bonds.
A large number of retail investors also rely on bonds for income. We should note that most individual bonds make payments twice a year. On the other hand, bond ETFs typically pay interest monthly, a feature that makes them attractive to regular income-seeking investors.
Bonds typically have a low correlation to equities. As a statistical measure, correlation shows how two investments have historically moved in relation to each other. Therefore, bond ETFs typically find a moderate place in portfolios and complement core equity holdings.
Rising Yields
While we discuss adding bonds to a portfolio, we also need to remind investors of the potential effect of interest rates. The SEC highlights: "Market interest rates and bond prices generally move in opposite directions."
Most countries, including the US, currently have record low-interest rates. However, as recent headlines indicate, governments may start to increase interest rates if inflation levels go up, affecting the value of bonds that have exposure to that country.
In recent days, the US 10-year Treasury yield saw its highest level since late March 2020 and moved above 1.7%. In January 2018, the yield was over 3.1%. Meanwhile, US government bonds hit their lowest point since the start of the pandemic about a year ago.
Most economists would concur that it is difficult to predict where the yields might go on a short-term basis. As a result, short-term bond market performance is also hard to forecast. However, over the next year or two, we expect a move toward 2.5% in 10-year Treasury yields.
Another important concept for bond investors is duration, a measure of the sensitivity of bond prices to interest rate movements. For example, if a bond has a duration of three years, its price would fall about 3% when interest rates rise 1 percentage point. On the other hand, the bond's price would go up about 3% when interest rates fall by 1 percentage point.
Thus, a high duration means a small change in interest rates could have a large effect on the value of the bond. Therefore, investors would need to pay attention to the duration of the ETF they are buying.
Holding investments with a maturity of more than 20 years could become a risky proposition. For instance, if a bond fund has an average duration of six years, it is usually accepted as being in the intermediate maturity category. Thus, it is less sensitive to interest rate fluctuations than funds with longer maturities. The closer a bond is to maturity, the less interest-rate risk it carries.
With that information, here's our fund for today.
ProShares Investment Grade-Interest Rate Hedged ETF
Current Price: $75.81
52-Week Range: $52.44 - $77.75
30-Day SEC Yield: 2.26%
Expense Ratio: 0.30%
The ProShares Investment Grade—Interest Rate Hedged (NYSE:IGHG) provides exposure to investment-grade corporate bonds. In addition, it aims to hedge against rising interest rates by taking short positions in US Treasury notes. Put another way, it tries to achieve an overall duration of zero, meaning no sensitivity to interest rate changes.
Therefore, the underlying debt securities become the focal point in this ETF, which currently holds 263 issues. The credit quality of these bonds, as assigned by S&P Global (NYSE:SPGI), ranges from AAA to BB.
Each issuer is limited to 3% of the market value of the investment-grade corporate position of the index. There are currently 112 issuers. Among the top names are Goldman Sachs (NYSE:GS), General Electric (NYSE:GE), Pfizer (NYSE:PFE), Citigroup (NYSE:C) and Vodafone (NASDAQ:VOD).
IGHG started trading in November 2013. Its assets under management stand at $462 million. The fund's top allocation is in the financial sector (41.11%). Next in line are Industrial-Manufacturing (16.03%), Industrial-Service (16.00%) and Industrial-Energy (9.96%). In general, rising interest rates, as well as economic growth that could likely follow the current vaccine rollout, would favor these industries.
Year-to-date, the fund is up 0.4% (or flat). But over the past 52 weeks, it has returned about 31%. It hit a 52-week high in late February.
For those who would like to park some of their capital in bond markets, IGHG, with its built-in hedge against interest rate risk, could offer an acceptable income level while not experiencing much price volatility risk.