Three Bond ETFs With Sub-Five Year Durations
As many bond investors already know, duration measures a bond's sensitivity to interest rate changes. The longer a bond's duration, the more sensitive it is to interest rate increases. Conversely, shorter duration bonds are less vulnerable to interest rate changes.
Speculation that U.S. interest rates could rise are part of the reason investors have continued to put cash to work in high-yield bond ETFs. Junk bonds often feature shorter durations than investment-grade corporates and highly rated government issues.
Investors looking to mitigate interest rate risk have plenty of compelling options among bond ETFs. Importantly, investors that consider the following ETFs are not sacrificing yield and, in some cases, nor are they incurring significantly higher credit risk. All of the ETFs featured here have average durations of less than five years.
WisdomTree Australia & New Zealand Debt Fund (NYSE: AUNZ)
The WisdomTree Australia & New Zealand Debt Fund has an effective duration of 4.05 years. Effective duration is the method for calculating duration on bonds with embedded options. As for AUNZ, its duration is slightly lower than the 4.73 years seen on the iShares Core Total U.S. Bond Market ETF (NYSE: AGG), but there are other, more prominent differences.
For example, folks say the U.S. dollar has recently been gaining strength. That is nice, but the Australian and New Zealand dollars have have been strong for several years. In fact, the Aussie and the kiwi have been the two best-performing developed market currencies against the greenback since the financial crisis. That is one benefit of interest rates of three percent and 2.5 percent in Australia and New Zealand.
Additionally, AUNZ offers a strong credit profile as 75 percent of its holdings are rated AAA because Australia has an AAA sovereign rating. The U.S. does not. With AUNZ investors also get a distribution yield that is nearly 50 basis points higher than what they would get with AGG.
Market Vectors Emerging Markets High Yield Bond ETF (NYSE: HYEM)
The rapidly growing Emerging Markets High Yield Bond ETF has an effective duration of 4.11 years. That is a sign that like U.S. junk bonds, emerging markets high-yield issues have lower durations compared to government debt.
For example, the iShares J.P. Morgan USD Emerging Markets Bond Fund (NYSE: EMB) has an effective duration of 7.6 years. Emerging markets high-yield corporates also compare favorably to their investment-grade counterparts in terms of duration. The SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (NYSE: EMCD) has a modified adjusted duration of nearly 5.8 years, according to State Street data.
On the surface, emerging markets junk corporates may indicate a higher rate of default, but that is not the case. Since the Argentine sovereign default earlier this century, default rates for high-yield emerging markets corporates have been consistently lower than in the U.S. Non-investent grade emerging markets corporates also saw lower rates of default than the equivalent U.S. bonds during the global financial crisis, according to Market Vectors.
The compensation is a little better with HYEM, too. The ETF has a 30-day SEC yield of 5.6 percent compared to 5.02 percent on the SPDR Barclays High Yield Bond ETF (NYSE: JNK).
PowerShares Chinese Yuan Dim Sum Bond Portfolio (NYSE: DSUM)
The PowerShares Chinese Yuan Dim Sum Bond Portfolio is an under-the-radar bond play perhaps because the ETF has just about $69 million in assets under management. It is a shame when investors pay attention to those shallow metrics because DSUM has climbed nearly 4 percent in the past year and features an effective duration of just 3.1 years.
Again, the assumption here is that because DSUM is an emerging markets play that investors are exposed to significantly higher credit risk. That is not necessarily the case as a third of the ETF's holdings are rated either AA or A by Standard & Poor's, though it should be noted that neither Moody's nor S&P rate half of DSUM's 83 holdings.
DSUM tracks the Citigroup Dim Sum (Offshore CNY) Bond Index, which is composed of RMB-denominated bonds issued by governments, agencies, supranationals and credit securities, excluding synthetics, retails and CDs. That index has outpaced the BofA Merrill Lynch Global Broad Market Non-Sovereign ex-USD Index year-to-date and over the past year, according to PowerShares data.
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