Bonds, of all things, are among the more perplexing investments these days.
Not only do investors have to contend with the confusing way their prices tend to rise as interest rates fall — bonds come in a staggering number of varieties; it’s difficult to figure out whether you’re getting a good price; and the individual bond at one broker might not be available from another broker.
Meanwhile, investors might have to spend $5,000 or more per bond to build a diversified portfolio. They can turn to mutual funds, but then it’s difficult to determine which bonds they’re holding, and such funds are only priced once a day, at the market close.
Add to that the unrelenting stream of cash flowing into bonds, which has raised concerns about a bubble, and it can be difficult to know which bonds to buy.
Given all these challenges, Marilyn Holt-Smith suggests using fixed-income exchange-traded funds, or ETFs.
“Individuals get into a lot of trouble in the fixed-income market if they don’t know what they’re doing,” said Holt-Smith, president and senior portfolio manager at Holt-Smith Advisors Inc. in Madison.
ETFs trade like stocks, are priced throughout the day and provide transparency because you can see what they are holding, Holt-Smith said.
There are 179 fixed-income ETFs, most tied to various indexes, according to Morningstar Inc. “So you can really slice and dice your fixed-income portfolio to do whatever you want,” Holt-Smith said. But that doesn’t mean you can buy them blindly.
Holt-Smith says her firm is favoring corporate bond ETFs over those that hold Treasuries because the yields are better. In this environment, she prefers to structure a portfolio of ETFs with an average maturity of five to seven years, and an average duration — a measure of interest-rate sensitivity — of 3.8 to four years.
iShares Barclays MBS Bond ( MBB, $108.92) invests most of its assets in the Barclays U.S. MBS Index, which contains mostly investment grade mortgage-backed securities. It has a distribution yield of 2.13%, an average life of 2.30 years, and is a good complement to the other ETFs because of its higher yield and shorter duration, Holt-Smith said. The fund’s 52-week range is $106.72 to $109.20.
iShares iBoxx Investment Grade Corporate Bond ( LQD, $120.35) invests most of its assets in iBoxx Liquid Investment Grade Index, which tracks investment-grade corporate bonds. It has a distribution yield of 4.07%, and a 12.11-year average maturity that helps it to offer more price appreciation potential, Holt-Smith said. This ETF owns 973 different corporate bonds, pays an attractive monthly yield and benefits in a flat to falling interest rate environment. The fund’s 52-week range is $109.81 to $120.92.
iShares Barclays Aggregate Bond ( AGG, $112.29) invests most of its assets in the Barclays U.S. Aggregate Bond Index, which tracks all U.S. investment-grade bonds. It has a distribution yield of 2.44%, a maturity of 6.32 years and a diversified portfolio that is not as vulnerable to individual credit risk, Holt-Smith said. The fund’s 52-week range is $107.25 to $112.68.
The biggest risk is the possibility that interest rates might rise and cause bond prices to drop, but Holt-Smith is not worried about that in the near future. Global economic slowing, and signs that the U.S. economy and employment are not picking up suggest the Federal Reserve won’t raise rates for a while, she said.
These ETFs are expected to continue to produce more income than ETFs that contain Treasuries with similar maturities, Holt-Smith said.
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