Bond ETFs have transformed fixed-income investing and are on the path to reach $5 trillion in AUM globally by 2030.7 Many advisors are turning to bond ETFs as a cost-effective way to provide clients liquidity, transparency and precise access to fixed income exposures.
When designing a client’s portfolio, it’s important to consider the three key roles bonds can play: equity diversification, capital preservation, and income. The prioritization of these objectives will vary depending on the client’s specific needs and broader asset allocation. The good news is today’s higher-rate regime has implications for each:
Equity diversification: For growth-oriented portfolios with substantial equity allocations, bond holdings should seek to provide a counterbalance. High-quality bonds have traditionally exhibited negative equity correlations, with 2022 (when both sides of the portfolio declined) being a notable exception.i
Going forward, investors can have more confidence in bonds’ diversification potential: rate moves can be less one-directional when the Fed stops hiking, and high starting yields act as a cushion for total returns.
If the primary goal is to provide diversification to clients’ equity allocations, advisors may consider the iShares Core U.S. Aggregate Bond ETF (AGG) and iShares U.S. Treasury Bond ETF (GOVT).
Capital Preservation: With their periodic cash flows and known maturity values, bonds have been commonly held for capital preservation. Lower maturity bonds tend to have less price fluctuations and can be used by investors to add stability to portfolios. However, for most of the last 15 years, low duration bonds also meant low return potential. If investors were looking for higher yields, then they would need to seek bonds with more credit risk or longer maturities. Today, short-term maturity bonds can offer both positive income and stability.
For capital preservation and the potential to earn more income than sitting in cash, advisors may consider adding the iShares 1-3 Year Treasury Bond ETF (SHY) and iShares 1-5 Year Investment Grade Corporate Bond ETF (IGSB) to client portfolios. It’s important to note that an investment in fixed income funds is not equivalent to and involves risks not associated with an investment in cash.
Income: From 2013 to 2021, high yield and emerging market debt were the only two fixed-income asset classes to offer more than 4% yields. Currently, over 50% of fixed-income assets yield over 4%. Income focused investors or investors without much equity market risk could consider accessing high yield bonds with iShares Broad USD High Yield Corporate Bond ETF (USHY) and emerging market debt with iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB).