Finding fixed-income ETFs is no problem. Picking the best bond ETFs to buy for the fixed-income portion of your portfolio now is a challenge, to say the least.
The biggest factor in the direction of bond prices and yields in the short run is the Federal Reserve’s monetary policy. The Fed announced on April 27 that it would leave interest rates unchanged, but kept the door open for a hike at the next meeting in June. The interpretation is that the Fed is showing patience and that it remains concerned about a soft patch in the U.S. economy.
The effect of the Fed taking a step back from the tightening mode can be positive for fixed-income ETFs in the short run. Plus, the Fed’s historical hesitance on raising rates near a U.S. presidential election might push the rate hike further down the road, especially if inflation remains at or below the target 2%.
In translation, barring an unforeseeable jump in economic activity and inflation, bond prices have more upside potential than downside.
Best Bond ETFs to Consider Buying Now
Investors have various reasons for buying bond ETFs. Some buy for price appreciation, some buy for income needs, and others buy for diversification purposes. There are also investors who may buy fixed-income ETFs for a combination of those reasons.
With that backdrop, I’ll share three bond ETFs that can suit the needs of any or all investors looking to fill a space in their fixed-income portfolios.
- PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEArca: ZROZ): If you’re looking for price appreciation, and you feel that the Fed will continue kicking the monetary tightening can down the road for most of 2016, zero-coupon funds like ZROZ may be the way to do it. Year-to-date in 2016, ZROZ is up more than 10% and there’s more room to run if the U.S. and global economies remain weak and inflation stays low.
- PowerShares Fundamental High-Yield Corporate Bond Portfolio Fund (NYSEArca: PHB): If you want high yields, PHB is one of the best fixed-income ETFs to buy now. PHB has an impressive yield of 5.37%. However, high-yield fixed income does not come without its risks. Most of the portfolio consists of bonds with credit ratings below investment grade. Therefore, PHB qualifies as a “junk bond” exchange-traded fund, which can have stock-like price declines when the economy significantly weakens.
- iShares Core US Aggregate Bond ETF (NYSEArca: AGG): If you’re looking for a fixed-income ETF for diversification purposes, and you don’t want to take any bets on what interest rates will do in the short term, AGG is your best bet. The portfolio provides exposure to the entire U.S. bond market, which consists of more than 5,600 debt securities, most of which are rated at or above investment grade.
For purposes of smart portfolio construction, a wise move might be to use all three ETFs – AGG as the core holding, which would receive the highest allocation percentage, and ZROZ and PHB as satellite holdings, each receiving relatively lower allocation percentages. This way you may minimize risk while optimizing return.
Kent Thune is the owner of an investment advisory firm in Hilton Head Island, S.C. He personally does not hold any of the aforementioned securities, although he holds AGG for some client accounts. Under no circumstances does this information represent a recommendation to buy or sell securities.
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