All of the uncertainty and speculation surrounding the Fed’s next move has moved investors’ attention away from bonds; however, there are some ETFs that warrant a closer look in a rising-rate environment.
With the S&P 500 down about 3% YTD and rate hike fears permeating Wall Street, it’s unlikely you’d consider bonds as a place to deploy your capital after the steep pullback seen in August.
Not All Bond ETFs Are “Scared”
You would be correct to assume that long-term bonds haven’t performed very well in 2015 (as of 9/15/2015), seeing as how rate hike expectations have only grown with every Fed meeting that passes: the worst performer, ZROZ, is down 13%, while the best, BJSM, is up just over 3%. However, you would be wrong to assume that all bond ETFs have performed dismally this year. Excluding leveraged and inverse products, there are over half a dozen ETPs that have returned more than 5% YTD, not bad during an otherwise unfriendly time period for investors.
Under the Hood
Let’s take a look under the hood of the top three of the seven products featured above in an effort to uncover some of the reasons behind their relative outperformance over domestic equities YTD.
US Treasury Steepener ETN (STPP ) up 10.12%
This runaway leader in the bond ETN space is designed to profit from a “steeping” in the U.S. Treasury Yield curve. To do this, STPP tracks the notional investment (remember it’s an ETN) in a weighted long position in two-year Treasury futures matched with a weighted “short” position in relation to ten-year Treasury futures. In effect, this ETN goes up when shorter-term dated Treasuries outperform their longer-term counterparts; and this is exactly the type of environment we’ve seen this year and is more than likely to persist.
US Treasury 2-Year Bull ETN (DTUL ) up 8.56%
This ETN is designed to increase in response to a decrease in the two-year Treasury note yield. Simply put, this product offers exposure to short-term Treasuries; again, these securities have outperformed their longer-term dated counterparts, giving this product an edge in the current environment.
Market Vectors Emerging Markets High Yield Bond ETF (HYEM ) up 7.89%
As the name says, this ETF comprises below-investment grade debt notes from outside the United States. The kicker here is that all of the underlying holdings are denominated in U.S. dollars, which has served as a tailwind for HYEM amid growing expectations of rising rates at home. While rates have remained low inside our borders, investors haven’t hesitated to diversify overseas in search of yield; especially with the growing availability of currency-hedged products that offer an added peace of mind for many.
Be sure to check out all currency-hedged ETFs.
The Bottom Line
Not all bond ETFs/ETNs are doomed just because the Fed is in the (very slow) process of shifting its policy. As demonstrated YTD, there are a number of unique bond ETPs that have raked in solid returns during an otherwise negative period for broad-based equity benchmarks; these may warrant a closer look from anyone looking to deploying cash outside the equity market following the August rout.
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