Investors Love This Bond ETF

With the Federal Reserve having cut interest rates twice this year and poised to cut some more, investors have the greenlight to pile into fixed income exchange traded funds and they are doing just that.

Year to date, five of the top 10 asset-gathering ETFs are bond funds, a quintet that includes the iShares 7-10 Year Treasury Bond ETF IEF. Only two bond ETFs have seen larger inflows this year than the $7.51 billion added to IEF.

The $18.68 billion fund tracks the CE U.S. Treasury 7-10 Year Bond Index and has 18 holdings, all of which are Treasuries with remaining maturities between seven and 10 years.

Why It's Important

IEF has an effective duration of 7.54 years, putting the fund in intermediate-term territory, making it suitable for investors that want more duration risk as the Fed lowers rates than is available on short-term bond funds.

The fund is cost-effective with an annual fee of 0.15% per year, or $15 on a $10,000 investment, making it attractive compared to many of the actively managed funds in this space, plenty of which have difficulty beating their benchmarks.

“It is difficult for active managers to offer comparable exposure and recoup their fees,” said Morningstar in a recent note. “This is because Treasuries are one of the most competitively priced areas of the bond market, and there is little leeway to take additional duration risk while staying in the constraints of the seven- to 10-year portion of the yield curve.”

What's Next

Due to the fact that IEF offers no credit risk, its 30-day SEC yield of 1.53% isn't considered high. To get a higher yield while sticking with Treasuries, investors would have to accept more interest rate risk. Conversely, IEF has the potential to deliver better returns than aggregate bond funds because those funds have high levels of duration diversity.

This fund is practical for investors looking for a low-risk way to augment equity-heavy portfolio with some fixed income exposure.

“This portfolio carries more interest-rate risk than funds that hold Treasury securities across the entire yield curve, but it's compensated with higher return potential,” according to Morningstar. “The shape of the yield curve can influence the attractiveness of this trade-off. The steeper the yield curve is, the better investors are compensated for the interest-rate risk.”

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Photo credit: Dan Smith  via Wikimedia Commons