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With just a handful of trading days left in 2014, the race for the best performing fixed-income ETF of the year has virtually been decided.
The interest rate environment this year has been one of persistent decline that has defied the odds of economists and central bankers that feared higher Treasury yields. The biggest beneficiaries of this decline have been on the long end of the yield curve, which was recently sitting near its lowest levels of 2014.
The ETF that was able to most successfully capture this sharp drop in interest rates is the PIMCO 25 Yr Zro Cupn US Ty Inx Fd ETF (NYSE: ZROZ). ZROZ has gained a whopping 43 percent year-to-date.
Related Link: Emerging Market Bond, Oil And Healthcare ETFs To Watch
PIMCO 25 Year Zero Coupon U.S. Treasury
ZROZ has benefited from having the highest effective duration of any ETF in the marketplace at 29 years. This makes it extremely sensitive to long-term interest rate fluctuations. In effect, ZROZ is a pure directional bet on a falling interest rate environment.
The high sensitivity to interest rates may be one reason why this fund has an understated asset total of just $92 million. ZROZ has just 21 underlying holdings, a 30-day SEC yield of 2.78 percent and a low expense ratio of 0.15 percent.
Comparison To Broad-Based Basket, AGG
Its returns, however, have far exceeded a broad-based basket of fixed-income in the iShares Barclays Aggregate Bond Fund (NYSE: AGG). This total bond ETF has gained 3.6 percent in 2014. AGG invests in a wide spectrum of treasury, mortgage and investment-grade corporate bonds with an overall effective duration of five years.
Runner Up: EDV
Runner up in the fixed-income category for 2014 is the Vanguard Extended Duration ETF (NYSE: EDV), which has posted a gain of more 38 percent. EDV implements a similar portfolio of ultra-long duration zero-coupon Treasury securities with an average maturity of 25 years.
While these ETFs set the bond world on fire in 2014, it remains to be seen whether a potential Fed rate hike next year will negatively impact these holdings. A new year will bring fresh opportunities and risks for fixed-income investors to navigate.
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