- Bond ETFs are an attractive option with interest rates falling.
- Bond ETFs have generally outperformed equity benchmarks in recent months.
- Here are three good options to diversify your portfolio with bond ETFs.
These bond ETFs should benefit from lower interest rates.
Bonds have always been a good way to diversify a portfolio, but in the current environment, some bond ETFs have the added benefit of generating returns that beat many stocks.
In the third quarter, bonds outperformed stocks, as the S&P 500 Bond Index returned 5.9% since July 1, while the S&P 500 has returned 5%. This is due in large part to higher volatility in the stock market caused by high valuations.
But with interest rates starting to decline, the market for bonds is expected to get even better. That’s because bond prices rise when interest rates fall. So, the best time to generate high returns from a bond ETF is to invest when interest rates are high but coming down — like they are now. This allows you as an investor to lock in high coupon yields and watch the value of bonds increase when rates fall.
“The all-important starting yields are higher than they’ve been for a long time and interest rates are likely ready to come down, starting in the second half of 2024 and continuing into next year. That’s the combination we’ve been waiting for,” David Braun, manager of the PIMCO Active Bond ETF, said in recent commentary from Fidelity Investments. “This is perhaps the most excited and bullish I’ve been on US core bonds in 15 years.”
Here are three of the best bond ETFs to buy now.
1. PIMCO Active Bond ETF
The PIMCO Active Bond ETF (NYSE:BOND) stands out for its historical performance as well as its active management, which will allow the portfolio management team, led by Braun, to find the most compelling bond investments.
The ETF focuses on higher-quality, intermediate-term bonds, selected using PIMCO’s top-down and bottom-up investment approach. The top-down strategy looks for forces likely to influence the economy and financial markets over the next three to five years, while the bottom-up approach drives the security selection process.
Currently, 58% of the portfolio is in securitized bonds, while 24% is in investment-grade credit and 13% is in U.S. government bonds. Around 54% have maturities of 5 to 10 years, while 17% mature in 3 to 5 years, and 15% have maturities of 1 to 3 years.
The ETF has a one-year return of 8.5%, which beats the Bloomberg U.S. Aggregate Index one-year return of 7.3%. It has a 10-year average annualized return of 2.01%, beating the benchmark’s return of 1.64%.
2. Vanguard Long-Term Bond Fund
The Vanguard Long-Term Bond Fund (NYSE:BLV) is focused on long-term U.S. Treasury and U.S. government bonds, which should serve it well as rates continue to fall.
Longer term bonds typically are more sensitive to rate changes than short-term bonds. When rates rise, they are more negatively impacted, but when rates start to fall, they generate higher returns because they pay the higher locked in rate for longer.
The ETF is passively managed, tracking the Bloomberg U.S. Long Government/Credit Float Adjusted Index. About 49% of this ETF is in longer-term U.S. government bonds, including Treasury and agency bonds. It also has exposure to investment-grade bonds.
The fund is up about 1.5% year-to-date, but it has surged over the past three months, returning 6.7%, beating the leading equity benchmarks. That type of performance should continue in this falling-rate environment.
The iShares 10+ Year Investment Grade Corporate Bond ETF (NYSE:IGLB) is a solid choice right now, for many of the same reasons as the Vanguard Long-Term Bond Fund.
But while that ETF focuses mainly on longer duration U.S. government bonds, the iShares 10+ Year Investment Grade Corporate Bond ETF invests in mostly long-term, investment grade corporate debt with maturities of 10 years or more.
Investment-grade corporate bonds are those issued by large, well-capitalized, often blue-chip companies, so while they are not as safe as U.S. Treasury bonds, they do generally have higher yields than U.S. government bonds because they are a bit riskier.
However, they are not as risky as high yield, or junk bonds. Currently, the largest holdings in the portfolio are solid companies like AT&T (NYSE:T), UnitedHealth (NYSE:UNH), Comcast (NASDAQ:CMCSA), Oracle (NYSE:ORCL), Verizon (NYSE:VZ), and Apple (NASDAQ:AAPL). Investors should feel fairly confident that these companies won’t default and that returns should rise due to falling interest rates.
The ETF is up just 1.7% YTD but has gained about 5.1% over the past three months. It has returned 10.2% over the past year and has posted a 2.5% average annualized return over the past 10 years. But with rates falling, it should see higher-than-average returns going forward.
Bond ETFs are always a good diversifier, but investors may want to increase their allocations slightly for what appears to be a relatively strong market for bonds right now.