By Karen Veraa
As widely anticipated, the Federal Reserve raised the Fed Funds rate from 0.25% to 0.25%-0.50% at the March Federal Open Market Committee (FOMC) meeting, its first ever rate hike. interest since December 2018. The Federal Reserve has a dual mandate; keeping stable prices (i.e. controlling inflation) and maintaining the economy at full employment. The central bank raised the federal funds rate to try to stay consistent with these goals:
- Stable Inflation: Higher interest rates have historically helped curb high inflation.
- Full employment: Many jobs have been created as the economy continues to recover from the effects of the global pandemic, giving the Fed the opportunity to raise interest rates to a level it says will not hurt not to economic activity and job creation.
In addition to the increase in fed funds rates, longer-term rates rose as the market priced in the path of future rate hikes. Rising interest rates can have a significant impact on bond investments, since bond prices fall when interest rates rise. However, bonds play a crucial role in portfolios as potential diversifiers and income generators.
Federal Funds Rate vs. 10-Year US Treasury Rate
Bond ETFs are an inexpensive way to help mitigate interest rate risk in your portfolio. Investors can consider the ETFs listed below to protect against rising interest rates and supplement or replace existing bond holdings.
Interest rate hedged ETFs: iShares Interest Rate Hedged Long-Term Corporate Bond ETF (IGBH) and iShares Interest Rate Hedged High Yield Bond ETF (HYGH) provide a cost-effective means of seeking to mitigate interest rate risk through a fund-of-funds structure that uses interest rate swaps, which reduces exposure to interest rate risk while maintaining the credit exposure.
Floating Rate Note ETFs: iShares Floating Rate Bond ETF (FLOW) and iShares Treasury Floating Rate Bond ETF (TFLO) offer exposure to floating rate US bonds and floating rate US Treasury bonds, whose interest payments adjust to reflect changes in interest rates. Floating rate bonds in FLOT and TFLO tend to have a shorter duration than fixed securities due to frequent interest rate resets.
Short-dated fixed-rate ETFs: iShares 1-5 Year Investment Grade Corporate Bond ETF (IGSB) and iShares Core 1-5 Year USD Bond ETF (BIST) hold fixed rate bonds with maturity profiles of 1 to 5 years, which currently offer reduced duration compared to broader maturity indices. IGSB invests in high-quality, short-term US corporate bonds, while ISTB invests in short-term, multi-sector core bonds. In addition to taxable fixed income, investors can also seek to shorten the duration of municipal bond portfolios with iShares National Short-Term Municipal Bond ETF (UNDER) and BlackRock Short Maturity Municipal Bond ETF (MEAR).
Rising rates can weigh on bond yields. By investing in interest rate hedging, floating rates and shorter duration exposures, investors can help protect their bond investments from rising rates.
© 2022 BlackRock, Inc. All rights reserved.
Consider the Funds’ investment objectives, risk factors and charges and expenses carefully before investing. This and other information can be found in the prospectuses of the Funds or, where applicable, the simplified prospectuses, which can be obtained by visiting the iShares Funds and BlackRock Funds flyer pages. Read the prospectus carefully before investing.
Investing involves risk, including possible loss of principal.
Risks associated with fixed income securities include interest rate risk and credit risk. Generally, when interest rates rise, there is a corresponding fall in the value of bonds. Credit risk refers to the possibility that the bond issuer may not be able to make principal and interest payments.
Lower quality debt securities (high yield bonds/junk bonds) may be subject to greater market fluctuations, risk of default or loss of income and principal than higher rated securities.
There can be no assurance that interest rate risk will be reduced or eliminated within the Fund.
The use of derivatives by the Fund may reduce the Fund’s returns and/or increase volatility and expose the Fund to counterparty risk, which is the risk that the other party to the transaction will not fulfill its contractual obligation. The Fund could incur losses related to its derivative positions due to a possible lack of liquidity in the secondary market and as a result of unforeseen market movements, which losses are potentially unlimited. There can be no assurance that the Fund’s hedging transactions will be effective.
Investing in a fund of funds is subject to the risks and charges of the underlying funds.
There may be less information about the financial condition of municipal issuers than for public companies. The municipal bond market may be less liquid than the taxable bond market. Certain investors may be subject to federal or state income tax or Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable.
Securities with floating or variable interest rates may lose value if their coupon rates do not keep pace with comparable market interest rates. The Fund’s income may decrease when interest rates fall because most of the debt securities held by the Fund will have floating or variable rates.
An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency and its return and returns will fluctuate with market conditions.
This document represents an assessment of the market environment as of the date indicated; is subject to change; and is not intended to be a prediction of future events or a guarantee of future results. This information should not be considered by the reader as research or investment advice regarding the funds or any particular issuer or security.
The strategies discussed are strictly for illustrative and educational purposes and do not constitute a recommendation, offer or solicitation to buy or sell securities or to adopt any investment strategy. There is no guarantee that the strategies discussed will be effective.
The information presented does not take into account commissions, tax implications or other transaction costs, which may significantly affect the economic consequences of a given investment strategy or decision.
Buying and selling ETF shares may incur brokerage commissions.
This document contains general information only and does not take into account any individual’s financial situation. This information should not be relied upon as the primary basis for an investment decision. Rather, one should assess whether the information is appropriate in the individual circumstances and consider speaking to a financial professional before making an investment decision.
The information provided is not intended to be tax advice. Investors should be advised to consult their tax or finance professionals for further information regarding their specific tax situation.
The Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).
The iShares Funds are not sponsored, endorsed, issued, sold or promoted by Bloomberg, BlackRock Index Services, LLC, Cohen & Steers, European Public Real Estate Association (“EPRA®”), FTSE International Limited (“FTSE”), ICE Data Indices, LLC, NSE Indices Ltd, JPMorgan, JPX Group, London Stock Exchange Group (“LSEG”), MSCI Inc., Markit Indices Limited, Morningstar, Inc., Nasdaq, Inc., National Association of Real Estate Investment Trusts ( “NAREIT”), Nikkei, Inc., Russell or S&P Dow Jones Indices LLC. None of these companies makes any representation regarding the advisability of investing in the Funds. Except for BlackRock Index Services, LLC, which is an affiliate, BlackRock Investments, LLC is not affiliated with any of the companies listed above.
Neither FTSE, LSEG nor NAREIT makes any representations about the FTSE Nareit Equity REITS Index, the FTSE Nareit All Residential Capped Index or the FTSE Nareit All Mortgage Capped Index. Neither FTSE, EPRA, LSEG nor NAREIT make any representations about the FTSE EPRA Nareit Developed ex-US Index or the FTSE EPRA Nareit Global REITs Index. “FTSE®” is a registered trade mark of the companies of the London Stock Exchange Group and is used by FTSE under licence.
© 2022 BlackRock, Inc. All rights reserved. BLACKROCK, BLACKROCK SOLUTIONS, BUILD ON BLACKROCK, ALADDIN, iSHARES, iBONDS, FACTORSELECT, iTHINKING, iSHARES CONNECT, FUND FRENZY, LIFEPATH, WHAT TO DO WITH MY MONEY, INVESTING FOR A NEW WORLD, BUILT FOR THESE TIMES, the iShares Core chart, CoRI and the CoRI logo are trademarks of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are the property of their respective owners.
This Publish originally appeared on iShares Market Insights.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.