Interest rate hikes have been among the Federal Reserve’s favorite tools for combating elevated inflation. Unfortunately, inflation still remains stubbornly above acceptable levels, so the Fed’s rate-tightening cycle is hardly over.
Meanwhile, financial advisors must both help their clients combat inflation and also protect income portfolios from the danger of rising rates. Let’s examine three ETF strategies that can help in this regard.
Floating-Rate Bonds
With just over $2.3 trillion in assets, BlackRock is still the top dog in the U.S. ETF market. And advisors who want to defend portfolios against rising interest rates might like the firm’s lineup of floating-rate bond funds.
Two strategies devised to help investors with today’s higher rate cycle are the iShares Floating Rate Bond ETF (FLOT) and the iShares Treasury Floating Rate Bond ETF (TFLO).
While each fund targets a different segment of the floating-rate bond market, the overall strategies of both are the same—the securities inside them tend to have lower durations since the interest rates are frequently reset, and the resets tend to be higher when rates are rising. The end result: higher yields with less duration risk.
Shorter-Duration High-Yield Bonds
Federated Hermes is a newer entrant into the ETF market, but the Pittsburgh firm offers investment solutions covering a diverse set of asset classes. The firm has around $669 billion in assets under management, and interest is picking up in its growing ETF lineup.
The Federated Hermes Short Duration High Yield ETF (FHYS) is an actively managed fund that balances investors’ demand for high income and their desire for dampened duration risk. At the end of January 2023, the fund had a 30-day SEC yield of 7.69%. It holds around 416 securities with a weighted effective duration of just 1.4 years.
“If you’re thinking short duration along with high yield, choosing one over the other is really not the right approach,” said Brandon Clark, the director of ETF business at Federated Hermes. The Short Duration High Yield ETF allocates between both areas, allowing income investors to participate.
The FHYS fund carries an annual expense ratio of 0.51%, and the three-person portfolio team has a combined 90 years of investment experience.
Preferred Securities
Another way to balance the risk of higher interest rates is through preferred securities, which have the characteristics of both stocks and bonds. In the ETF arena, one of the best-kept preferred securities secrets is the AAM Low Duration Preferred & Income Securities ETF (PFLD).
This fund’s indexing strategy takes a novel approach by limiting the duration of its portfolio. At the end of last year, almost half of the portfolio’s holdings had durations of less than a year. This has helped the fund navigate the wrath of rising rates better than competing products with longer durations, such as the iShares Preferred and Income Securities ETF (PFF).
The AAM Low Duration Preferred & Income Securities ETF charges annual expenses of 0.45%. It distributes monthly income, and its total assets are approaching $200 million. The fund’s 30-day SEC yield was a competitive 6.33% as of February 24, 2023.
Summary
Advisors need to stay on top of today’s fast-changing market. With interest rates still on the rise, more damage is ahead for income portfolios that aren’t properly positioned and protected. Thankfully, carefully selected ETFs can help with the latter.