With Bond ETFs, Keep It Short Again In 2019

It may not have been easy money, but embracing short-term bonds and the corresponding exchange traded funds has easily been one of this year's most popular fixed-income trades.

With 2019 right around the corner, some bond market observers believe managing duration risk will again be a trade to embrace in the new year.

What Happened

The Federal Reserve raised interest rates four times in 2018, and while there is speculation the benchmark U.S. interest is getting close to “normal” or “neutral,” there is also chatter that the Fed has a couple more rate hikes in store for 2019.

In this rising rate environment, it's unsurprising that this year's most popular bond ETFs are all of the short-term variety. Of the three bond funds among this year's top 10 asset-gathering ETFs, each is a low or ultralow duration product.

Why It's Important

In terms of new assets added among bond ETFs, the iShares Short Treasury Bond ETF SHV and the iShares 1-3 Year Treasury Bond ETF SHY lead the way. SHV and SHY have added a combined $21.36 billion in new assets this year.

“With a flat yield curve and relatively tight credit spreads today, you don’t need to take on much interest rate risk or rely on higher-risk assets like stocks to generate income potential,” BlackRock said in a Friday note. “High-quality ultrashort and short duration bonds are sitting in a sweet spot right now: they offer potentially attractive yields, and their short duration means they’re less exposed to interest rate risk (duration).”

SHY has an effective duration of 1.85 years while SHV's effective duration is 0.42 years.

What's Next

With the Fed not ruling out more rate hikes in 2019 and a surprisingly hawkish tone emerging from the central bank's December meeting, SHV and SHY could be popular again next year.

“Consider that the two-year Treasury currently yields nearly 3 percent, according to Bloomberg,” said BlackRock. “Rotating into an ETF like the iShares 1-3 Year Treasury Bond ETF (SHY) can be a low-cost way to up the overall credit profile of your portfolio.”

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