Bonds: Total Market
Bond ETFs ae set to break a landmark record this year—$1 tn in AUM. The number is a big deal for bond ETFs, which got off to a slower start than their equity counterparts. In recent years, though, bond ETFs have seen huge inflows as they allow investors a more liquid option for both strategic and longer-term allocations. The market is also seeing a good deal of innovation, with more nuanced approaches spreading much like they have in equities.
FINSUM: Overall this is excellent news for investors. More AUM means more liquidity, more options, and lower costs. There are still some fears about a liquidity mismatch between the ETF and the underlying blowing up during a crisis, but those have never materialized.
Investors are anxious about the chances of a recession right now. While the Fed doesn’t seem likely to hike us into one any longer, economic fundamentals have just begun to show cracks. It started with housing, then job growth for February, and now it is jobless claims. Jobless claims rose by 6,000 last week after a long stretch of falling numbers. Weekly numbers are seen as less reliable than monthly figures because of random gyrations, but the data could indicate the economy is starting to soften.
FINSUM: It is too early to tell whether this is indicative of a coming softening or just an aberration, but certainly something to pay attention to.
The reality is that the Fed has been hiking steadily, and investors should expect 2-3 more hikes in 2019. That means that adjusting one’s portfolio is a must. One thing to remember is that there are now plenty of ETFs that are designed to not lose from rates rising and still give an easy 2-3% yield. This is a big change from the post-Crisis paradigm, where safety meant negligible yields. One conservative way to play the environment is the SPDR Barclays 1-3 Treasury Bill ETF (BIL). Another is the iShares Floating Rate Bond ETF (FLOT), which only yields 2.5%, but with very little rate risk. One much more intriguing option is the WisdomTree Barclays U.S. Aggregate Bond Negative Duration ETF (AGDN). This fund holds a long bond position coupled with a short Treasury position with a target duration of -5 years, meaning it is designed to gain when rates rise.
FINSUM: This is a good selection of ETFs, and that Wisdomtree option looks quite interesting. It truly seems a way to profit as rates rise.
One of the big developments of this month is not just that stocks have been getting hammered, but that bonds are too. While yields have stagnated from their jump a couple weeks ago, bond funds are seeing major outflows. In fact, investors are withdrawing so much capital from bond funds that it is likely to be the worst month for outflows in the last three years. Through October 19th, investors had pulled almost $25 bn from mutual funds and ETFs that invest in bonds. The losses break 21 straight months of inflows.
FINSUM: A couple things to note here. Firstly, considering Treasuries started the year yielding 2.4% and are now at 3.13%, one month of outflows does not seem too bad. On the negative side, however, it is worrying that bonds are seeing major outflows at the same time as stocks are losing in a big way.
Inflation is rising across the globe, including in the US. Perhaps more pressingly, the Fed seems absolutely intent on hiking rates as the economy continues to perform very strongly. With that in mind, profiting from rising rates, or at least insulating one’s portfolio, needs to become a priority. Accordingly, here are some ETFs to help: iShares Floating Rate Bond ETF (FLOT), the SPDR Blmbg Barclays Inv Grd Flt Rt ETF (FLRN), the ProShares High Yield—Interest Rate Hdgd (HYHG), the SPDR Portfolio Short Term Corp Bd ETF (SPSB), and the Vanguard Short-Term Corporate Bond ETF (VCSH).
FINSUM: The ProShares fund seems the most interesting of the lot as it invests in high yield bonds while shorting Treasuries to protect against rate hikes, all while delivering less rate sensitivity than regular short-term bonds.
With rates rising and yields finally responding in a big way, you may have been wondering which ETFs tend to perform well in such periods. With that in mind, here is a list of the best performing ETFs in periods of rising rates (since 2008). The stats are from thirty day periods of rising rates, which have occurred 18 times since 2008. The best four are: VanEck Vector Oil Services ETF (6.53% average gain), the SPDR S&P Regional Banking ETF (4.9%), the United States Oil Fund ETF (4.54%), and the SPDR S&P Oil & Gas Exploration & Production ETF (3%).
FINSUM: Oil and banking, not really a surprise, but certainly a good reminder for investors. The worst performing funds in the same period tended to be gold funds.