concerns over an interest rates hike sooner than expected are high. This has lowered the appeal for risky yield plays.
This is especially true, as high-yield funds shed $7.07 billion in the week ended August 6, including $1.3 billion in ETFs. The outflow surpassed the previous record of $4.6 billion that was pulled out in the week ended June 5, 2013,according to Lipper. Notably, junk bond funds saw about $1.14 billion and $5.4 billion in outflows in June and July, respectively.
In fact, the ultra-popular junk bond ETF – iShares iBoxx $ High Yield Corporate Bond ETF (HYG) – saw a massive outflow of more than $1.2 billion over the past four weeks, followed by $939.4 million in PIMCO 0-5 Year High Yield Corporate Bond (HYS) and $509.3 million in SPDR Barclays Capital High Yield Bond ETF (JNK). The ETFs were down 1.6%, 1.2% and 1.7%, respectively, in the same time period.
Volatility crept up in the past few weeks. Rising geopolitical tension in Russia, ongoing violence in the Middle East, a bloody Gaza strip, Argentina default, Portuguese banking woes, Chinese slowdown and a struggling European economy dampened the demand for riskier assets, including equities.
Further, the Fed monetary policy report last month raised concerns about stretched valuations in the lower-rated corporate debt space. The International Monetary Fund also highlighted the weakness in this high yield space, suggesting that more pain is in store for this asset class.
If this wasn’t enough, record low yields, declining market liquidity as well as stringent regulations and higher capital requirements by the banks could derail the high-yield debt market further in the coming months. As a result, investors are shifting their preference to the ‘safe haven’ fixed income world avenues such as German Bunds and U.S. Treasuries (read: Safe Haven ETFs to Evade Geopolitical Tensions).
What Should Investors Do?
While short-term Treasury bond ETFs generally provide a decent option to play in the current turmoil, mid and long-term Treasury counterparts could emerge as true winners. This is because the yield on the 10-year Treasury note has presently dropped to a 14-month low at below 2.4%. Meanwhile, the yield on the 10-year German government bond has fallen to a record low near 1%.
Investors could consider long-term Treasury ETFs such as iShares 20+ Year Treasury Bond ETF (TLT) and Vanguard Extended Duration Treasury ETF (EDV). TLT gathered more than $399.6 million over the past four weeks, propelling its total asset base to more than $4 billion. The fund is the most popular and liquid ETF in the long-term bond space and tracks the Barclays Capital U.S. 20+ Year Treasury Bond Index. Average maturity comes in at 27.13 years and the effective duration is 16.92 years.
On the other hand, EDV provides exposure to the long-term Treasury STRIPS market by tracking the Barclays U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index. The fund has average maturity of 25.4 years and average duration of 24.9 years. The fund is slightly cheaper by 3 bps when compared to TLT and generated higher returns of 4.3% in the trailing one-month period versus 2.4% for TLT. Both products have a Zacks ETF Rank of 3 or ‘Hold’ rating.
In the mid-term Treasuries space,iShares 7-10 Year Treasury Bond ETF (IEF) and iShares 3-7 Year Treasury Bond ETF (IEI) could be solid picks in a rocky market. Both funds have a Zacks ETF Rank of 3 and collectively gathered $2.7 billion in capital over the past month. Though both products are popular and charge 15 bps in annual fees, IEF is more actively traded than IEI.
The former tracks the Barclays U.S. 7-10 Year Treasury Bond Index with average maturity of 8.43 years and effective duration of 7.56 years. On the other hand, the latter follows the Barclays U.S. 3-7 Year Treasury Bond Index, and has weighted average life and effective duration of 4.78 years and 4.55 years, respectively. Both products returned less than 1% in the same time period.
Apart from U.S. Treasury bond products, investors could look at PIMCO Germany Bond Index ETF (BUND), which provides concentrated exposure to euro-denominated, investment grade bonds from German issuers. This fund tracks the BofA Merrill Lynch Diversified Germany Bond Index with effective maturity of 5.46 years and effective duration of 4.89 years (read: Guide to European Bond ETF Investing).
This German bond ETF is unpopular and illiquid with AUM of just $3.2 million and average daily volume of 100 shares per day. As a result, total cost for this product comes in much higher than the expense ratio of 0.45% due to a wide bid/ask spread. The product is considered less attractive when compared to the U.S. Treasury counterparts as it lost 2.1% in the same time period.
This article is brought to you courtesy of Sweta Killa from Zacks.