By Juliette Fairley
In a bid for yield with some liquidity, investors are turning to fixed-income exchange-traded funds that, in some cases, have produced juicy returns.
The highest-returning category for the year and year-to-date ended September 5 is high-yield muni ETFs, with returns of 15.61 percent and 12.69 percent, respectively, according to Morningstar. In second place is long-term bond ETFs, up 13.01 percent for the year and 9.62 percent year-to-date as of September 5.
"We don't know when interest rates will rise meaningfully. It could be next year or the year after, so don't count on 15 percent returns from the high-yield muni category in 2013," says Timothy Strauts, a fixed-income analyst with Morningstar in Chicago.
The largest ETFs are the iShares Barclays Bond Fund (TIP) with $23 billion in assets, the iShares iBoxx Investment Grade Corporate Bond Fund (LQD) with $24 billion and the Vanguard Total Bond Market Index Fund (BND) with $17 billion in assets.
Combining the larger fixed-income ETFs for yield, credit quality and inflation protection is a good strategy, according to Todd Rosenbluth, an ETF analyst with S&P Capital IQ in New York.
"If your client wants inflation protection, then the TIP fund makes sense. LQD has the highest yield with lots of single- and triple-B rated bonds like AT&T, Wells Fargo, WalMart and Citigroup. It's riskier, but it's still investing in stable credit and not high-yield bonds," said Rosenbluth. "If you want diversification or exposure to all bonds, then BND is appropriate, which gives less yield but greater credit quality."
The iShares Barclays Bond Fund (TIP) was up 5.59 percent year-to-date and up 6.37 for the year as of September 5, compared with iShares iBoxx Investment Grade Corporate Bond Fund (LQD), which was up 9.08 percent and 10.56 percent, respectively. The Vanguard Total Bond Market Index Fund (BND) is up 3.63 percent year-to-date and 4.74 percent for the year.
"LQD has higher performance numbers because it's taking on more credit and duration risk. TIP is made up of U.S. Treasury bonds with an inflation rider so they are safer than corporate bonds because they are backed by the U.S. government and not by a company," Strauts says. "BND is a more diversified investment because it's a benchmark of the bond market that encompasses the entire investment grade U.S. bond market, which includes government bonds, mortgage bonds and corporate bonds."
"These are some of the largest fixed-income ETFs out there and they could not be more different. Each has different yields and exposure to different sectors within the fixed-income world and each will get you different credit quality and interest rate sensitivity," says Rosenbluth. "All three can provide exposure to fixed-income assets at a low cost structure."
The iShares Barclays Bond Fund (TIP) has an expense ratio of 20 basis points while the iShares iBoxx Investment Grade Corporate Bond Fund (LQD) has an expense ratio of 15 basis points compared with 10 basis points for the Vanguard Total Bond Market Index Fund (BND) with $17 billion in assets.
When interest rates go up, bonds will likely lose money, but until then fixed-income ETFs can offer significant performance. "The difference between ETFs and mutual funds that invest in fixed-income products is that ETFs offer niche areas, such as corporate emerging market bonds or long-dated corporate bonds, whereas fixed-income mutual funds' assets are generally found in intermediate bonds," said Strauts.