Last week I wrote about how 2021 has been an unusual year for fixed income.
On the one hand, rates are up. On the other, they aren’t up nearly as much as many would have imagined they would be given the inflation environment.
Case in point: The iShares Core U.S. Aggregate Bond ETF (AGG) is only down 1.4% this year, even with inflation running at a 40-year high.
In other words, fixed income assets have held up extremely well this year. In fact, some pockets of the market have even generated solid gains. Here we take a look at some of those outperforming fixed income ETFs.
Closed-End Funds Strategy
Near the top of the fixed income heap are two products from Rareview—the Rareview Dynamic Fixed Income ETF (RDFI) and the Rareview Tax Advantaged Income ETF (RTAI).
Both products are funds of funds focused on fixed income closed-end funds (CEFs). RDFI invests across the space, while RTAI targets municipal bond CEFs.
These are strategies that have performed well this year, generating returns of 11.2% and 9.8%, respectively.
According to Rareview, it invests in CEFs with high distribution yields; the potential for principal appreciation; and the potential to generate alpha through changes in CEF discounts-to-NAV.
The issuer points out that the average yield in its target universe of fixed income CEF holdings is 6.72%. RDFI currently has about half of its portfolio invested in noninvestment-grade credit.
In addition to the Rareview ETFs, there are a few other CEF-focused fixed income ETFs on the best performers list. The VanEck CEF Muni Income ETF (XMPT) is up 6.8% year-to-date and the First Trust Municipal CEF Income Opportunity ETF (MCEF) is up 7.4%.
Extra Yield With Preferreds
Moving across the best performers list, the VanEck Preferred Securities ex Financials ETF (PFXF) makes an appearance, with a gain of 9.3%.
Preferred stocks have characteristics of both equity and debt. They typically offer a sizable dividend that’s safer than the dividends of a company’s common stock, but not as safe as the interest payments on a company’s bonds. Additionally, preferred stock can sometimes be converted into common stock.
Preferreds are essentially a way to capture higher yields than corporate bonds, but with higher risk if the company faces hard times.
Junk Bonds Outperform
The Sound Enhanced Fixed Income ETF (SDEF) is another fund that’s done well, with a return of 7.8%. This is an actively managed fund that invests across the fixed income landscape. The ETF holds about half its portfolio in investment-grade debt securities and the other half in below-investment-grade debt securities.
Indeed, as has been the case with SDEF, having exposure to below-investment-grade fixed income securities—also known as high yield bonds or junk bonds—has paid off this year as credit spreads remained narrow. The difference in yield between junk bonds and Treasurys briefly narrowed to a 27-year low in July before expanding modestly since then.
Junk bonds performed well this year as investors grew more optimistic about the health of the U.S. economy. A more robust economy translates into fewer defaults for the least creditworthy companies.
The “fallen angel” ETF, the VanEck Fallen Angel High Yield Bond ETF (ANGL), has done particularly well by holding bonds of issuers that have recently been downgraded from investment grade to junk—essentially the highest-rated junk bonds on the market. It’s up 6.2% this year.
The High Yield ETF (HYLD), the PGIM Active High Yield Bond ETF (PHYL) and the FlexShares High Yield Value-Scored Bond Index Fund (HYGV) are a few other high yield bond ETFs that have outperformed this year, with gains of around 5% year-to-date.
TIPS Hedge Against Inflation
Rounding out the best-performers list is a category of fixed income ETFs that is particularly relevant today with inflation running at multidecade highs—Treasury inflation-protected securities (TIPS) ETFs.
TIPS can be used to hedge against higher inflation while maintaining an investor’s exposure to the Treasury bond market.
If inflation runs hotter than what is currently embedded in markets, the government will compensate TIPS holders. Essentially, with TIPS, you are locking in a particular “real” (inflation-adjusted) interest rate. With conventional bonds, you are locking in a nominal rate.
When inflation runs hotter than expected, TIPS outperform. And when inflation is less than expected, regular bonds outperform. This year, with inflation running far higher than anyone expected, ETFs focused on TIPS are delivering strong returns.
The iShares 0-5 Year TIPS Bond ETF (STIP) and the Invesco PureBeta 0-5 Yr U.S. TIPS ETF (PBTP) are each up around 5%, sharply outperforming other Treasury bond ETFs. The ProShares Inflation Expectations ETF (RINF), which goes long TIPS while shorting conventional Treasurys—a more aggressive fund than the others—is up 11.6% so far this year, the best performance of any fixed income ETF year-to-date.
For a full list of this year’s best-performing fixed income ETFs, see the table below:
Best-Performing Fixed Income ETFs Of The Year (ex. leveraged funds)
Data measures total returns for the year-to-date period through Dec. 14, 2021.
Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2
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