Bond ETF Ideas For Rising Rates

The Federal Reserve's two-day meeting, its last of 2016, concludes Wednesday, and if the Fed funds futures market is accurate, it would be stunning if the U.S. central bank did raise interest rates.

November was unkind to bonds and fixed-income exchange-traded funds. In fact, data suggest short sellers eagerly targeted bond funds last month. Two bond ETFs remain among this year's top 10 asset-gathering ETFs, but that's well below the peak seen earlier this year when as many as five or six of the 10 best asset-gathering ETFs were bond funds.

However, some fixed income ETFs have been packing on assets since November 2, the date of the last Fed meeting, indicating that some investors are identifying areas of the bond market that can thrive even when borrowing costs creep higher.

Rates, Bonds And Strategies

Standard strategies for sticking with bonds while rates rise include low duration funds and those ETFs that feature interest rate hedges. There are some surprising ideas to consider, including active ETFs such as the SPDR DoubleLine Emerging Markets Fixed Income ETF EMTL, which debuted earlier this year.

Rising rate “environments historically tend to favor risky assets, such as equities and high yielding fixed income sectors like high yield bonds, senior loans and emerging market debt (EMD),” said State Street Vice President David Mazza in a recent note. “During an economic expansion, investors may also require less risk premium, another tailwind for high yielding bonds and EMD.”

Well-Timed EMTL

While the same cannot be said of all new ETFs, EMTL's debut was well timed. The ETF came to market during an environment where investors are embracing emerging markets assets for the first time in several years and when anemic developed world bond yields are increasing the allure of emerging markets debt. Actually, emerging markets debt is often the more desirable destination than equities.

In fact, emerging markets bonds have a lengthy history (the past decade) of offering vastly superior returns relative to emerging equities.

Holdings, Allocations

EMTL, which holds 54 bonds, has a modified duration of 4.66 years. Mexico, India and Panama are the new ETF's largest geographic allocations, combining for 36 percent of the ETF's weight. Currently, EMTL devotes about 53 percent of its weight to corporate bonds with the remainder being sovereign or quasi-sovereign issues.

About 46 percent of EMTL's holdings are rated either Baa2 or Baa3, with another 27 percent rated between Aa2 and A3.