With the U.S. Federal Reserve expected to hike U.S. interest rates several times this year, there’s more talk on the subject of “interest rate risk,” meaning fluctuations in rates that could hurt the value of investors’ portfolios.
Bond prices are inversely correlated with interest rates, falling as rates climb and rising when they fall. So when it comes to maturities, long-dated bonds with 20-year durations or longer are those that would be hit the hardest by rising rates.
Various economists have been guessing about the Fed’s timetable for rate increases of 25 basis points or more, which they believe could come anywhere from three to six times in 2022.
Let’s examine a few ETF strategies that combat the threat of higher rates.
Low Duration Preferred Securities
One such strategy is the AAM Low Duration Preferred & Income Securities ETF (PFLD). The strategy is designed to balance an investor’s need for yield income with capital protection. The fund hedges against the threat of higher rates by investing in shorter duration U.S. dollar-denominated hybrid debt and preferred stock publicly issued by U.S. companies.
For investors not sure about whether to choose stocks over bonds or vice versa, preferred securities offer the characteristics of both and are a nice middle ground.
At the end of last year, the PFLD fund carried a 30-day SEC yield of 5.26% with a securities duration average of just 1.17 years. The fund charges 0.45% annually and income distributions occur monthly.
Floating-Rate Bonds
Although income payments from floating-rate bonds are variable, income payments generally increase when interest rates are climbing. This makes them less sensitive to higher rates and an attractive choice for yield-hungry investors.
The iShares Floating Rate Bond ETF (FLOT) carried a 30-day SEC yield of 0.29% as of January 26, 2022. Although that may not seem like much, the FLOT fund has been stable, despite the warnings of an interest rate tsunami. The fund has posted a year-to-date loss of only 0.04%, besting bond funds with longer-term maturities, including the iShares 20+ Year Treasury Bond ETF (TLT), a fund that lost 3.45% (and whose size makes it a barometer for the space).
The FLOT fund charges annual expenses of 0.15%, and more than 52% of its portfolio is allocated to quality U.S. dollar-denominated bonds with a credit rating of “A” or better.