Tag Archives: coupons

Bond ETFs To Play If Fed Hikes In June

With the U.S. economy on the mend after a lukewarm Q1, a Fed rate hike possibility in June is back on the table. At least, the latest Fed minutes suggest that. A spate of stronger U.S. economic data in the field of retail, consumer sentiment, inflation and housing must have boosted the Fed’s confidence. The labor market and the manufacturing sector also seem sound. However, the June hike possibilities came as a shock to investors as they grossly shifted back the timeline of a hike in the wake of moderation in U.S. growth. Whatever the case, further Fed rate hikes are likely to bring in changes in investing sentiments. Against this backdrop, those who have started speculating a sooner-than-expected hike in the Fed interest rates must be worrying about the stability of their fixed income holding. Investors should note that yields on short-term bonds started to move higher since the release of the minutes. The yield on three-month bonds was 0.31% on May 19, 2016, up 3 bps from the yield recorded on May 17, 2016. Fixed-income investing has enjoyed a great show so far in 2016, especially in the longer part of the yield curve. However, the prospect of rising rates and risks to capital gains of bond holdings have left investors jittery about the safety of their portfolio. Given the situation, many investors are definitely pulling their money out of the bond market. At a time like this when investors are extremely cautious about rising rate risks and stock market volatility, investments in the below-mentioned bond ETFs can be intriguing bets. WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration ETF (NASDAQ: HYND ) If investors are worrying about interest rate risks, negative duration bonds may come to rescue. Plus, this fund offers substantial yields which can easily beat out the benchmark yield. In addition, risks over junk bond investing are easing now with the ongoing energy sector recovery. This fund tracks the BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained, Negative Seven Duration Index. The benchmark is a combination of the long and short portfolio. The long portfolio mirrors the BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained Index, targeting non-investment grade corporate debt securities issued in the U.S. and maturing in five years. The short portfolio holds the short positions in U.S. Treasuries that surpasses the duration of the long portfolio, resulting in a targeted total duration of about negative 7 years. The fund puts heavy focus on junk bonds. It has a fee of 48 bps. The fund yields 4.55% annually (as of May 19, 2016). Sit Rising Rate ETF (NYSEARCA: RISE ) The ETF looks to track the performance of a portfolio comprising exchange-traded futures contracts and options on futures on two-, five- and 10-year U.S. Treasury securities weighted to attain the targeted negative 10-year average effective portfolio duration. Through this method, the ETF would see a 10% price appreciation with a 1% rise in U.S. Treasury yields. SPDR DoubleLine Total Return Tactical ETF (NYSEARCA: TOTL ) TOTL, an actively managed fund, has its foundation based on the principles of the DoubleLine’s sought-after investment research. The product seeks total return, while emphasizing income by investing in a global portfolio of fixed income securities of various maturities and ratings, though more-or-less 10% of the portfolio goes to the international arena. The fund looks to utilize various investment strategies in a broad array of fixed income sectors. It puts about 55% of assets in mortgage-backed securities. The fund charges 55 bps in fees. The fund has a modified adjusted duration of 3.90 years while its current yield stands at 2.58% (as of May 19, 2016). VanEck Vectors Investment Grade Floating Rate ETF (NYSEARCA: FLTR ) Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers. Since the coupons of these bonds are adjusted periodically, these are less sensitive to an increase in rates compared to traditional bonds. Investors can thus play the theme with FLTR. Effective duration of the fund is as low as 0.13 years. SPDR Barclays 1-10 Year TIPS ETF (NYSEARCA: TIPX ) The fund looks to track the Barclays 1-10 Year Government Inflation-linked Bond index. Since the inflation picture is improving in the U.S. and a solid inflationary outlook is a prerequisite of the Fed tightening policy, this TIPS ETF can be considered a good bet. The fund has moderate interest rate risk as noted by modified adjusted duration of 4.71 years. SPDR Nuveen Barclays Capital Build America Bond ETF (NYSEARCA: BABS ) Investors should note that the short-term bond ETFs would be under greater pressure if the Fed acts in June. The yield on the 10-year U.S. Treasury note actually fell 2 bps to 1.85% on May 19, 2016 from the earlier day while the yield on three-month treasury notes increased by one basis point. This pattern should help long-term bond investing. For this reason, we chose this muni bond ETF which yields about 3.15% annually (as of May 19, 2016). These bonds are safer than high-yield corporate bonds. Original Post

Third Avenue Focused Credit’s Investor Freeze Re-Affirms Advantage Of Closed End Funds

Third Avenue Focused Credit shutting the gate on redemptions. A reminder that traditional open-end mutual funds can suffer “runs on the bank” if they hold illiquid assets during nervous market periods. Reminds us that closed end funds are the safer vehicle to hold high yield and other more illiquid asset classes. Third Avenue Focused Credit Fund ( TFCIX , TFCVX ) just dropped the bombshell that they are freezing the fund and barring investor withdrawals as it seeks an orderly liquidation. TFCIX, as a sort of “vulture fund,” operates at the lowest end of the high-yield bond spectrum, specializing in bankruptcies, turnarounds and other bottom-of-the-barrel opportunities. I had personally been quite enamored of the fund when it was launched in 2009 as a vehicle to take advantage of post-crash credit market bargains. In that sense I saw it as a vehicle for retail investors to get in on the opportunities typically only available to hedge fund and other institutional investors. The fund’s “Achilles Heel” turned out to be its status as a traditional “open end” mutual fund, where investors could liquidate their positions on a daily basis. In fact, in recent years it was the only open-end mutual fund I had continued to hold, feeling personally more comfortable with closed end funds where, if other investors want to bail out, they have to sell their fund on the open market, and cannot demand the funds’ portfolio managers cash them out at NAV by selling fund assets. That is a much safer vehicle for holding potentially illiquid assets, as high yielding assets like junk bonds, MLPs, BDCs, etc. have turned out to be recently. I started selling out my TFCIX a few months ago (as I explained in an article in early November), not because I was worried about the fund freezing its assets (I wasn’t that smart), but rather because I saw a unique opportunity, since it was an open-end fund offering cash back at full NAV value, to take advantage of that and put the funds back into the market via closed end funds at 10% discounts (or more.) So that’s what I did, completing my exit later in the month. By way of post mortem, I ran the numbers on my total investment in TFCIX over the past six years. I collected back 34% of the total investment in dividends over the holding period, about 8% per annum, accounting for the timing of the investment (i.e. it wasn’t all outstanding the entire period). Then I gave back about 25% of the total investment in capital loss. That means I only made about 9% in total on my money, spread over 6 years. An opportunity cost, for sure, and a waste of earning power, since if invested better it would have been earning 6-7%. But – fortunately – not a disaster. To me this reinforces: · The attractiveness of closed end funds as the vehicle of choice for holding high-yielding illiquid assets, since you have the option of sitting out periods of market volatility while clipping your coupons and waiting for the storm to pass; and · The advantages of holding high yielding assets (equity and fixed income) in general, as a hedge against market losses, since the cash flow acts as a buffer over time to offset market depreciation.

ETF Tactics For A Rate-Proof Portfolio

With back-to-back months of solid jobs growth and moderate inflation, the era of tightened policy might kick in as early as in two weeks, as the chance of the first rate hike in almost a decade now looks more real. The Fed is slated to increase interest rates at its upcoming December 15-16 policy meeting, but at a gradual pace. The initial phase of increase will actually be good for stocks as it will reflect an improving economy and a lower risk of deflation. Plus, higher rates would attract more capital to the country, thereby boosting the U.S. dollar against the basket of other currencies. However, since a strong dollar should have a huge impact on commodity-linked investments, a rising rate environment will also hurt a number of segments. In particular, high-dividend-paying sectors such as utilities and real estate would be the worst hit given their higher sensitivity to rising interest rates. Further, securities in capital-intensive sectors like telecom would also be impacted by higher rates. In such a backdrop, investors should be well prepared to protect themselves from higher rates. Here are number of ways to create a rate-proof portfolio that could prove extremely beneficial for ETF investors in a rising rate environment: Bet On Rate-Friendly Sectors A rising rate environment is highly beneficial for cyclical sectors like financial, technology, industrials, and consumer discretionary. Investors seeking protection against rising rates could load up stocks in these sectors through diversified or niche ETFs. Some of the broad ETFs having double-digit exposure to these four sectors are the iShares Core S&P Total U.S. Stock Market ETF (NYSEARCA: ITOT ), the Schwab U.S. Broad Market ETF (NYSEARCA: SCHB ), and the iShares Russell 3000 ETF (NYSEARCA: IWV ). Other sectors make up for a smaller part of the portfolio of these funds. Investors seeking a concentrated exposure to the particular sector could find the iShares U.S. Financial Services ETF (NYSEARCA: IYG ), the Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the First Trust Industrials AlphaDEX ETF (NYSEARCA: FXR ) and the Consumer Discretionary Select Sector SPDR ETF (NYSEARCA: XLY ) intriguing. All these funds have a Zacks ETF Rank of 2 or “Buy” rating, suggesting their outperformance in the coming months. Focus On Ex-Rate Sensitive ETF The timing of interest rates hike is resulting in higher market volatility. For protection against both, the PowerShares S&P 500 ex-Rate Sensitive Low Volatility Portfolio (NYSEARCA: XRLV ) could be an ideal bet. This fund provides exposure to 100 stocks of the S&P 500 that have both low volatility and low interest rate risk. This approach looks to exclude the stocks that tend to underperform in a rising interest rate environment, and is tilted toward financials (28.1%), industrials (21.5%) and consumer staples (15.2%). As such, XRLV is a compelling choice to play the rising rate trend. Follow Niche Bond ETF Strategies Though the fixed income world will be the worst hit by rising rates, a number of ETFs like the iShares Floating Rate Bond ETF (NYSEARCA: FLOT ) and the iPath U.S. Treasury Steepener ETN (NASDAQ: STPP ) that employ some niche strategies could see huge gains. This is because a floating-rate note ETF pays variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of the issuers. Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. On the other hand, the Steepener ETN directly capitalizes on rising interest rates and performs better when the yield curve is rising. The ETN looks to follow the Barclays US Treasury 2Y/10Y Yield Curve Index, which delivers returns from the steepening of the yield curve through a notional rolling investment in the U.S. Treasury note futures contracts. Shorten Bond Duration Higher rates have been cruel to bond investors, especially the longer-term ones, as an increase in rates has always led to rising yields and lower bond prices. This is because price and yields are inversely related to each other and might lead to huge losses for investors who do not hold bonds until maturity. As a result, short-duration bonds are less vulnerable and a better hedge to rising rates. While there are several options in this space, the SPDR Barclays 1-3 Month T-Bill ETF (NYSEARCA: BIL ), the iShares Ultrashort Duration Bond ETF (BATS: NEAR ) and the Guggenheim Enhanced Short Duration ETF (NYSEARCA: GSY ) with durations of 0.16, 0.36 and 0.17 years, respectively, seem intriguing choices. Original post