Investors wishing to reallocate risk have turned to bond exchange-traded funds (ETFs), which can hold corporate, municipal, treasury or international bonds. In recent days, trading in US bond ETFs has hit record volumes as investors reposition their portfolios in anticipation of further rate hikes by the (Fed).
Analysts also noted trading volumes for corporate bond funds hit a record $25 billion. Similarly, government bonds traded $18 billion.
Bond ETFs differ from traditional bonds in several ways. For example, while bonds have a fixed maturity date, principal is due, bond ETFs never mature. Thus, when a bond in the portfolio of a given fund matures, another bond is purchased to keep the maturity of the portfolio constant.
Most readers would do well to know:
“The term of a bond, or the years to maturity, is usually fixed when it is issued.”
But maturity is sometimes confused with the duration or sensitivity of a bond’s price to changes in interest rates.
The duration is expressed in years. Suppose a bond has a duration of 3 years. When interest rates increase by 1%, the price of the bond decreases by about 3%. Most investors who expect rates to rise generally look at bonds with shorter durations.
In the case of bond ETFs, the duration generally represents the weighted average of the duration of the individual bonds in the portfolio. So, if a bond fund has a duration of five years, a 1% increase in interest rates should lower the overall net asset value of the ETF by 5%.
Finally, it is worth mentioning the concept of yield to maturity (YTM), or the annualized return that an investor will receive when holding a bond until maturity. And for an ETF, YTM represents the weighted average return of all bonds in the portfolio if held to maturity.
With this information, let’s look at a bond ETF to diversify portfolios.
iShares Short Maturity Bond ETF
- Current price: $49.25
- 52 week range: $49.21 – $50.17
- Average yield at maturity: 3.24%
- Spending rate: 0.25% per year
The iShares Short Maturity Bond ETF (NYSE:) invests in short-term bonds. The fund was first listed in September 2013 and has net assets of nearly $4.5 billion.
About a quarter of the portfolio is made up of higher quality industries; followed by non-U.S. credit-linked, investment-grade financials, asset-backed securities, and commercial mortgages.
Bonds on NEAR’s list have varying maturities, but are all short-term. Accordingly, the effective duration is 0.54 years or less than 200 days. In other words; if interest rates rise by 1%, the net asset value should fall by approximately 0.5%. Therefore, investing in this ETF is like holding cash.
Meanwhile, the weighted average maturity is 1.38. In other words, the portfolio would mature in 1.38 years. So if the ETF were to close without liquidation, it would take 1.38 years for the holdings to mature, returning the principal.
NEAR currently has 374 holdings. Among the top names on the list are Morgan Stanley (NYSE:), Bank of America (NYSE:), volkswagen (ETR:), JPMorgan Chase (NYSE:), Citigroup (NYSE:)and AbbVie (NYSE:). These are companies that most investors are familiar with. And since they are investment grade, the ETF’s credit risk is low.
So far in the year, NEAR is down 1.38%. This diversified bond fund does not completely eliminate the broad market. Still, it might appeal to readers looking for an ETF to park their money for the short term.