Fight the Fed with these bond exchange-traded funds
Bond ETF investors have been fighting the Fed since taper headaches began last year, and now the Federal Reserve is prepared to help.
As Chairman Ben Bernanke leads his last meeting and the consensus is that the Fed likely will continue winding down its bond-buying program, the U.S. is offering a new bond product—for the first time since 1997. The Treasury Department will offer some $15 billion in floating-rate 2-year securities in an auction Wednesday.
Floating-rate bond funds and ETFs have been among the most popular fixed-income offerings, with investors worried about an eventual rise in interest rates as the Fed winds down quantitative easing. The new product already has one of the biggest ETF companies hooked.
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"It speaks to two things investors are looking for today: less interest rate risk ... and safety in U.S. Treasurys," said Matt Tucker, head of iShares fixed-income group. BlackRock's iShares manages more than $180 billion in bond ETFs and $40 billion in short-duration bond ETFs.
The firm has registered an ETF for the floating-rate government issue with the Securities and Exchange Commission and hopes to launch it soon as iShares TFLO.
"Look at the last couple of weeks," Tucker said. "People are flocking to Treasurys."
Fed-sensitive bonds right now
The Fed is going to be the main driver of interest rates over the coming months, he said. Short- and long-term bonds appear to be stable, but investors should focus on intermediate bonds as these bonds could be in for higher rates.
The one- to three-year bond ETFs, such as iShares Barclays 1-3 (SHY), and the 20-year-plus bond ETFs, such as iShares Barclays 20 Yr. (TLT), which already sold off, should be stable. But bond ETFs focused on issues in the three to seven-year range, such as iShares Barclays 3-7 Year Treasury (IEI), are the most sensitive to Fed decisions right now, Tucker said.
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High-yield bonds also have been in favor among bond investors amid the search for yield and ratcheting up of the risk profile.
While high-yield is volatile, Tucker said, "the fundamentals look very good." Corporations are sitting on piles of cash, defaults are low and Fed policy has been accommodative.
Price appreciation may not be as great as it had been in high-yields, such as the iShares iBoxx Hi Yld Corp (HYG), but the income opportunity is still strong, he said.
"Five percent clipping a coupon, if interest rates don't go through the roof, if they don't, that's not a bad proposition," said Bob Pisani, CNBC "On-Air Stocks" editor in his interview with Tucker at ETF.com's Inside ETFs conference in Hollywood, Florida.
The emerging market fiasco has investors moving to Treasurys. It's no different in emerging market bond ETFs: Expect a bumpy ride, Tucker said.
If you are already in a fund such as IShares JPMorgan USD Emerging Markets Bond ETF (EMB), hold on to it, as investors likely will be able to ride it out, he said. If you are looking to buy into emerging market bonds now, though, it may not be the best time.
—By Anthony Volastro, Segment Producer, CNBC. Follow him on Twitter @VolastroCNBC