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The ETF Income Conundrum: Balancing Yield and Risk


Benchmark yields have remained stubbornly low, but we are looking a higher interest rates in the future. Consequently, bond exchange traded fund investors are taking a hard look at their fixed-income portfolio.

More investors are looking into income strategies for today’s markets, positioning portfolios to withstand rising interest rates. For the advisors who are interested in learning more about fixed-income ETFs strategies, ETF Trends and RIA Database are hosting the annual ETF Virtual Summit, an online conference experience, on January 21.

In a rising rate environment, older bonds with lower yields are less in demand. To attract demand, the price of pre-existing bonds would have to diminish enough to match the same return yielded by prevailing interest rates. Consequently, we typically see an inverse relationship between yields and a bond’s price where a rising rate environment would correspond with falling bond prices.

As a way to hedge the potential fallout in the fixed-income market ahead, investors are beginning to take a closer look at holdings and alternative investment options. Some have considered floating rate bonds and related ETFs to hedge rate risks.

For instance, the Market Vectors Investment Grade Floating Rate (FLTR) tracks U.S. dollar-denominated floating rate notes issued by corporate issuers with an investment-grade rating. The floating rate notes have a so-called reset period with interest rates tied to a benchmark, such as the Fed funds, LIBOR, prime rate or U.S. Treasury bill rate, so rising rates have a minimal effect on the securities. [Floating Rate ETFs for Rising Rates Protection]

FLTR shows a 0.10 year duration, which roughly translates to a 0.10% decline if interest rates were to rise 1%. The ETF also has a 0.65% 30-day SEC yield.

Additionally, the Market Vectors Treasury-Hedged High Yield Bond ETF (THHY) provides another option to access high-yield, junk bonds while hedging against rising rates. Specifically, the fund’s underlying index employs a type of long/short strategy where it will go long junk bonds and short 5-year Treasury bonds to hedge against adverse movements in interest rates. THHY shows a 0.29 year duration and a 5.12% 30-day SEC yield. [Long/Short Bond ETFs to Hedge Rate Risk, Generate Yields]

Additionally, investors could move down the yield curve and target more short-term bonds to remain in the fixed-income game. For instance, the FlexShares Disciplined Duration MBS Index Fund (MBSD) , with a 2.94 year duration and a 2.38% 30-day SEC yield, tracks mortgage-backed securities with a disciplined duration approach. The FlexShares Credit‐Scored US Corporate Bond Index Fund (SKOR) , which has a 4.66 year duration and a 2.37% yield, focuses on investment-grade corporate bonds with middle maturities ranging from two to 10 years.

Advisors interested in attending the upcoming ETF Virtual Summit on Wednesday, January 21 can register here.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.