Bond ETFs to Cope With Rising Interest Rates

Published July 16, 2013

| Benzinga

Yields on 10-year U.S. Treasurys have come in a bit over the past few days and reside at 2.54 percent at this writing. That is down from 2.73 percent on July 5, but 10-year yields are still sharply higher over the past three months. On April 16, the yield was just 1.75 percent, according to Treasury Department data.

Those rising rates have claimed plenty of victims among bond ETFs. Speculation that the Federal Reserve will soon stop buying mortgage-backed securities has sent the iShares CMBS ETF (CMBS) lower by nearly two percent over the past 90 days. Over the same time, the iShares 20+ Year Treasury Bond ETF (TLT), more sensitive to rate changes because of its longer duration, has plunged 11.2 percent. Even the beloved PIMCO Total Return ETF (BOND) is off nearly 4.5 percent.

Rising rates need not chase investors from all bond ETFs. Some have been holding up nicely while others may have been beaten up more than warranted given the ability of those funds to remain sturdy if rates continue to rise. Some examples follow.

SPDR Barclays Convertible Securities ETF (CWB) Convertible bonds are often referred to as debt instruments, but remember that "convertible" usually means convertible into shares of the issuers common stock. That gives these bonds some sensitivity to equity markets, which diminishes some of the interest rate risk.

As for the $1.3 billion CWB, it tracks the "Barclays U.S. Convertible Bond > $500MM Index, an index that tracks United States convertible bonds with outstanding issue sizes greater than $500 million," according to State Street. Over 28 percent of its holdings come from technology sector issuers while consumer non-cyclicals and financials combine for another 33.3 percent.

RELATED: Surprising ETF Options for Rising Rates

When it comes to helping investors play defense against rising rates, CWB actually helps them play offense as a 90-day gain of 4.24 percent indicates. CWB's 30-day SEC yield is almost 2.5 percent.

SPDR Barclays Short Term High Yield Bond ETF (SJNK) Overall, high-yield bond ETFs have not impressed as rates have risen. That is likely the case of widening spreads relative to Treasurys. Those wider spreads imply declining issuer credit quality. If creditworthiness is faltering and junk bonds are perceived as overvalued, bond traders are apt to exploit the opportunity by shorting high-yield. More conservative investors will merely leave junk alone in favor of risk-free Treasurys.

Well, SJNK has held up well all things considered with a 90-day loss of just 1.1 percent. Since junk bonds have shorter durations than most government debt, investors' concerns are more focused on creditworthiness than rate risk. The point of SJNK is to be a shorter duration alternative to traditional high-yield bond ETFs and that is with a modified adjusted duration of just 2.25 years.

While investors may be pulling money from some junk bond ETFs, SJNK is still attracting assets. On April 23, the ETF had $1.2 billion in AUM. Today, it has $1.56 billion.

PowerShares Senior Loan Portfolio (BKLN) BKLN is basically a junk bond ETF senior loans, also known as leveraged or syndicated loans, are made by banks to companies with sub-investment grade credit ratings. What makes BKLN appealing as a rising rates play is that senior loans are floating rate debt, which helps temper the interest rate risk. The average years to maturity for BKLN's 131 holdings is about 5.2 years.

The success of BKLN and new rivals previously prompted some talk of a senior loan bubble, but that has not even come close to happening. BKLN also fights off liquidity concerns by rarely trading at noticeable premiums or discounts to its net asset value, something that happened just once in the previous three quarters, according to PowerShares data.

Not only is BKLN down just 1.1 percent in the past 90 days, it has hauled in almost $1.5 billion in assets over that time.

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