Stepping Off The Sidelines With Fixed Income ETFs (FLOT, CSJ, SHV, LQD, HYG)

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November 18, 2011 2:46pm NYSE:CSJ NYSE:FLOT

Matthew Tucker: A few weeks ago, my colleague Russ blogged about the preference skittish investors are showing for cash. Given the volatile market conditions and uncertain political environment, it’s understandable that investors are finding comfort in cash.


But Russ gave three reasons why moving to cash might be a mistake, and he said it is worth considering keeping some equity exposure. I agree with Russ that staying on the sidelines could be a mistake, and I would emphasize that for investors looking to reduce portfolio risk there are a number of fixed income ETF solutions available.

For investors who crave the comfort of cash, short duration vehicles could be a good way to dip your toes into the fixed income market. Here are three reasons why:

1. No long-term commitment

Fixed income ETFs trade throughout the day on a stock exchange, giving you flexibility and the ability to nimbly adjust your exposure. Say, for instance, you become concerned about risk. You can sell a risky asset class and access a fixed income ETF intra-day. If the market changes, you can then sell the ETF and re-deploy your proceeds.

2. Potential for higher yields than money market funds

iMoneynet reports that the 30-day average yield on money market funds as of November 8 is 2 basis points. Investors who do not seek a stable net asset value and who are looking for higher yields may find fixed income ETFs to be an interesting option. For investors who want to keep interest rate risk low, but who are comfortable taking on some credit risk, the iShares Floating Rate Note Fund (NYSEARCA:FLOT) offers investors a 30-day SEC yield of 1.45% as of November 10 with a duration (a measure of interest rate sensitivity) of only 0.14 years. For investors comfortable taking on a low level of both interest rate and credit risk, the iShares Barclays 1-3 Year Credit Bond Fund (NYSEARCA:CSJ) has a 30-day SEC yield of 1.42% as of November 10 with a duration of 1.85 years. There are also lower risk options like the iShares Barclays Short Treasury Bond Fund (NYSEARCA:SHV) that has a 30-day SEC yield of 0.04% as of November 10 but that invests solely in US Treasury securities. Past performance does not guarantee future results. For standardized fund performance, please click on the following tickers: FLOT, CSJ, SHV.

The key is that an investor has the control to select exactly the exposures they want, and, by extension, avoid the exposures they don’t want.

3. Less volatile than longer-term funds if interest rates rise rapidly

Short-duration investments will have lower interest rate sensitivity than longer-term funds. For example, the 0.12 year duration of FLOT means that we can generally expect FLOT’s price to decline by 0.12% if interest rates rise by 1%. By comparison the iBoxx $ Investment Grade Corporate Bond Fund (NYSEARCA:LQD) has a duration of 7.51, meaning that we could generally expect its price to decline 7.51% if interest rates rose by 1%.  (Potential iShares solutions: FLOT, SHY, or CSJ)

The bottom line is that investors who are looking for yields above those provided by money market funds have a range of options to choose from. Just keep in mind that yield isn’t free — it always comes along with some type of extra risk. By understanding what risks you are willing to take and constructing a short duration portfolio appropriately, an investor can design a wide range of potentially higher yielding alternatives to traditional cash vehicles.

Disclosure: Author is long FLOT and SHV

Source: Bloomberg

The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com.

An investment in fixed income funds is not equivalent to and involves risks not associated with an investment in cash or money market funds.

For differences on mutual funds and ETFs, please click here.

Buying and selling shares of iShares Funds will result in brokerage commissions.

Bonds and bond funds will decrease in value as interest rates rise. Securities with floating or variable interest rates may decline in value if their coupon rates do not keep pace with comparable market interest rates. Narrowly focused investments typically exhibit higher volatility and are subject to greater geographic or asset class risk. The Funds may be subject to credit risk, which refers to the possibility that the debt issuers will not be able to make principal and interest payments. The iShares Floating Rate Note Fund’s income may decline when interest rates fall because most of the debt instruments held by the Fund will have floating or variable rates. An investment in the Funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.

Written By Matthew Tucker From The iShares Blog

Matthew Tucker has spent the past 16 years focused on fixed income analytics, portfolio management and strategy. As managing director of U.S. fixed income strategy at BlackRock, Inc., and a member of the Fixed Income Portfolio Management team, Mr. Tucker leads both product strategy for ETFs and North America and Latin America iShares strategies, as well as product delivery and client sales. He previously worked with Barclays Global Investors before it merged with BlackRock, and he led the U.S. Fixed Income Investment Solutions team responsible for overseeing product strategy for active, index, enhanced index, iShares and long/short products. Mr. Tucker was also a portfolio manager and a trader in fixed income focused on U.S. government securities.

He began his career at Barra, where he supported clients using the company’s fixed income analytics. Mr. Tucker holds a bachelor of business administration degree from the University of California, Berkeley, and is a Chartered Financial Analyst charterholder.


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