Lower volatility, high yield with ultra-short bonds

This article was produced in partnership with Franklin Templeton.

Investors are always seeking the right balance between risk and reward. Amid lingering uncertainty around inflation and interest rates, some investors are discovering the perfect balance in ultra-short bonds.

With maturities of less than one year, ultra-short bonds can reduce an investor’s prolonged exposure to defaults and fluctuating rates, while providing a higher yield than other low-risk options such as savings accounts or money market funds.

“They’re a good place to be, potentially earning an attractive yield while limiting exposure to market risks,” says Brian Calder, vice president at Franklin Templeton Fixed Income - Bissett Investment Management and co-lead manager of the Franklin Bissett Ultra Short Bond Active ETF (FHIS).

“The curve is steeply inverted and you really don't need to extend duration to earn attractive yields,” he says. “We're looking at potentially getting 5% or more for extremely short duration.”

Calder, who helps manage almost $5 billion across several funds from his office in Calgary, highlighted another potential benefit of investing in ultra-short bonds ahead of more potential rate hikes by the Bank of Canada.

“The fund is much more responsive to interest rates than conventional, longer-term securities,” he adds. “It’s nimble enough to capture the benefits of higher rates without suffering some of the negative effects of those higher rates.”

Looking ahead on inflation and rates

Calder says the Bank of Canada has managed to rein in inflation to a significant extent but now they’re encountering some of the stickier contributions to higher prices.

To reach their goal of 2% inflation, he believes there’s still some work to do.

“We don't see them cutting anytime soon,” Calder says. Rate cuts will likely be delayed until later next year and we're quite comfortable how we are positioned for that.”

He adds, however, that a more globally connected world equates to more unpredictable markets, and there’s always a possibility of another shock that upsets the transition to lower rates next year.

Who should hold ultra-short bonds?

Investors are usually attracted to short-term bonds for their superior liquidity and reduced volatility. The trade-off to these advantages was lower yield.

But that has changed today. “Due to the shape of the inverted yield curve, there’s no real sacrifice with yield,” Calder, says. “You're being paid attractively to reduce your volatility.”

Ultra-short bonds serve as a great partner to longer-term bonds within an investor’s strategy. Instead of sitting on the sidelines or investing in a money market fund with low returns, an investor can acquire both yield and flexibility without giving up stability.

Calder points to another advantage of the Franklin Bissett Ultra Short Bond Active ETF (FHIS): a fee of just 15 basis points.

“We saw there was an opportunity in this space, and we wanted to be competitive,” Calder explains. “We understand that investors in this space are price sensitive and we’re delivering an actively managed solution at a low cost.”

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