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First Trust Launches New Short Duration Bond ETF

Zacks Equity Research

The short-term bond space has gained quite a lot of popularity in the past few months, given the anticipation of rising interest rates. A gradually improving U.S. economy and a strengthening labor market have raised concerns of an earlier-than-expected rate increase. Thus, sitting on the short side of the duration curve would help negate the threat of rising interest rates.
 
In order to capture the most of the surging popularity in the space, First Trust has recently launched a new product – First Trust Enhanced Short Maturity ETF (FTSM) – focusing on short-term bonds that reduce interest rate risk (read: Prepare for Rising Rates with These ETFs).
 
FTSM in Focus
 
The actively managed product seeks to provide current income, with a focus on capital preservation. For this purpose, the fund invests in U.S. dollar denominated short term investment grade securities. As such, the fund has a weighted average maturity of 0.77 years and an average duration of 0.27 years, indicating negligible interest rate risk.
 
Moreover, the fund invests in a broad range of asset classes to provide diversification. However, money market securities dominate the fund with roughly two-thirds of fund allocation, followed by 12.7% allocation to Mortgage/Asset Backed Securities and 10% allocation to Floating-Rate Corporate Bonds.
 
Holdings-wise, the fund holds a small basket of 25 securities which are quite concentrated among its top 10 holdings. Arrow Electronics, Kansas City and Nisource Finance occupy the top three spots with more than 8% allocation each.
 
The fund also has the flexibility to strategically rotate among various sectors according to market conditions. However, even while doing so, the fund attempts to maintain its objective of capital preservation and providing liquidity (read: Protect Your Portfolio with These Multi-Asset Income ETFs).
 
FTSM charges 35 basis points as expenses.
 
How does it fit in a portfolio?
 
The recently launched fund could be an attractive solution for investors given the potential for rising interest rates. The Fed is expected to wind up its bond buying program this November, and speculations are rife it will start raising rates by next year. In fact, some of the recent positive economic data have raised speculations about an earlier-than-expected rate hike.
 
With interest rate hike risk looming larger over the bond markets, short-term bonds which have low interest rate risk will be better options to bet upon. Short-term bonds are relatively less volatile than medium and long-term bonds when the interest rates are rising (read: 5 Inverse ETFs for A Shaky Market).

Can it succeed?

While there are just a limited number of funds in the ultra short-term bond ETF space, FTSM could face stiff competition from PIMCO Enhanced Short Maturity Exchange-Traded Fund (MINT).

The fund is the most popular product in its space with an asset base of $3.8 billion and an average trading volume of over 250,000 shares a day. The actively managed product invests in short duration investment grade debt securities, having an effective maturity of 0.53 years and an effective duration of 0.49 years.

Guggenheim Enhanced Short Duration ETF (GSY) is another fund in this space, and it has an asset base of $702 million and an average trading volume of more than 120,000 shares a day. The actively managed fund uses a low duration strategy to outperform the Barclays Capital 1-3 Month U.S. Treasury Bill Index. GSY has a weighted average duration of 0.47 years and an average maturity of 1.18 yeas.

Given the huge popularity of the above actively managed short duration products, it could be hard for FTSM to stand out. The fund might have low trading volumes initially as well (read: AdvisorShares Launches New Low Duration Bond ETF).

However, thanks to its actively managed approach and flexible strategy, it may be a better choice among other ultra short-term bonds. Also, given the uncertainty over interest rates, the fund might be able to attract more inflows as investors seek to switch from long-term bonds to short-term bonds to protect their portfolios from volatility.

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