Forget Interest Rate Risk With These Bond ETFs (FLOT, BIL, PVI)

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November 21, 2012 5:03pm NYSE:BIL NYSE:FLOT

Eric Dutram: Despite looming worries over a bond bubble, investors continue to pile into fixed income products. The space has seen an impressive amount of inflows in the past few months, and with equity market weakness as of late, this trend could definitely continue.


Yet the specter of rising interest rates is always hanging over the market, threatening to eventually crush those who have bought long-dated bond investments. When rates eventually move higher, those who took on risk for yield could be in for a world of pain as bond prices collapse in order to readjust to a new reality (read Three Bond ETFs for a Fixed Income Bear Market).

Although with how uncertain the equity market has been as of late, one cannot blame investors for taking on some interest rate risk for the impressive stability that comes with fixed income investments. But instead of looking to long dated bonds with their more impressive payouts, those searching for stability in the bond market may want to consider low-duration securities for their exposure.

While these securities do not pay out much in the way of income, they are unlikely to be hard hit by a sudden spike in interest rates either, thanks to their low duration approach. Due to this, these could be better prepared for a move higher in rates while still offering up solid levels of stability that investors are probably craving given this uncertain market (read 3 Actively Managed Bond ETFs for Stability and Income).

For investors interested in taking this technique, we have highlighted three of our favorite bond ETFs below that minimize interest rate risk and employ a low duration approach. While the yield or price appreciation for these three might not be that much, they are likely to be bastions of stability no matter what happens in the broader equity or fixed income markets.

iShares Floating Rate Note Fund (NYSEARCA:FLOT)

It is hard to be too hurt by interest rate changes when your securities have a variable interest rate, much like those that occupy the holdings list of FLOT. This fund tracks the Barclays US Floating Rate Note < 5 Years Index, holding about 233 notes in total (readFloating Rate Bond ETF Investing 101).

The 30-Day SEC yield for this product is about two-thirds of a percent—better than most—due to the fund tracking securities that pay out a rate equal to LIBOR plus a fixed coupon spread. Still, the effective duration is just 0.15 years thanks to the resetting of LIBOR, suggesting that this product will not suffer greatly from big interest moves either.

SPDR Barclays 1-3 Month T-Bill ETF (NYSEARCA:BIL)

For a Treasury play on low duration securities, BIL fits the bill. The product hones in on Treasury bonds that mature within three months, ensuring that the products have next to nothing in both interest rate risk as well as default risk.

As a result, the yield is pretty much zero percent although the average maturity is just 0.13 years while the annualized volatility is just 0.02. Clearly, this fund will be tough to beat for investors looking for bond stability without some of the interest rate worries that we are seeing in other corners of the market.

PowerShares VRDO Tax-Free weekly Portfolio (NYSEARCA:PVI)

If investors prefer a municipal bond approach, PVI is an interesting choice with an extremely low duration. The fund seeks to match the Bloomberg US Municipal AMT-Free Weekly VRDO Index, a benchmark that zeroes in on Variable Rate Demand Obligation notes which have interest rates that are reset on a weekly basis (read VRDO Municipal Bond ETF Showdown: VRD vs. PVI).

This weekly reset ensures that the effective duration is next to nothing despite the fund having an average years to maturity of just under 20 years. The fund has 40 securities in its basket and a fee of 25 basis points a year, although once again the yield is pretty much zero.

Written By Eric Dutram From Zacks Investment Research   

In 1978, Len Zacks discovered the power of earnings estimates revisions to enable profitable investment decisions. Today, that discovery is still the heart of the Zacks Rank, a peerless stock rating system whose Strong Buy recommendation has an average return of 26% per year.


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