The current fixed-income environment opens a uniquely attractive window for short-maturity instruments
In light of the current rising-rate environment, it’s a smart move for investors to go into fixed-income options that shield them from interest-rate risk. That apparently isn’t lost on Canadian ETF investors as they favoured bond funds with floating-rate and short-term exposures in July, according to a recent article from the Globe and Mail.
While floating-rate funds are a fine haven from duration risk, a flat yield curve gives short-maturity bonds a dual advantage. “In exchange for lower risk, these issues typically generate lower income than longer-maturity bonds,” noted Karen Schenone, fixed income product specialist at BlackRock, in a recent commentary. “The current market environment is unusual, however.”
Because short bonds are providing similar yield to their longer-maturity counterparts, Schenone said, investors pay a smaller cost to reduce their interest-rate risk. That means mutual funds or ETFs that hold diversified portfolios of bonds less than five years in duration should be quite appealing.
The opposite movements of bond prices and yields, she added, means that decreases in bond prices are offset by increases in income. An analysis of fixed-income performance shows that short-maturity bonds do well in that respect.
Examining performance indexes for different fixed-income instruments — ultra-short 1- to 12-month US T-bills, 1- to 3-year treasuries, 1- to 3- year credit, and floating-rate notes — from November 2015 to June 2018, she found that ultra-short bounds had very little price movement while increasing income contributions over the comparison period. Short-maturity instruments both had price losses, but saw increased income with rising rates.
But “the clear winner over this period was floating rate notes, which had positive returns for both price and income,” Schenone added. Floating-rate bonds adjust interest payments in line with changing interest rates — a desirable feature when rates rise.
She noted, however, that the choice of fixed-income exposure should also depend on the investor’s holding period and investment objectives.
