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Eric Dutram

Forget About Low Rates With These Three Bond ETFs

PZA LWC ISHG

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As a result of the weak economy, Ben Bernanke and the Fed have pushed rates to historically low levels and seem poised to keep them there for the foreseeable future, even despite some mildly improving fundamentals. This decision has greatly hurt savers and those on a fixed income, pushing down current income levels of a variety of lower-risk investment products. Beyond CDs and deposit accounts, this extremely low rate environment has caused many to reconsider bonds as well. Instead, some are looking to ramp up exposure to dividend paying equities as a way to supplement yield in this uncertain time, especially if Bernanke’s pledge to keep rates low until 2014 materializes.

Yet high yielding equities probably aren’t the solution for everyone, especially for investors approaching retirement or those with a low risk tolerance. Stocks can move violently in a short period of time in a way that bonds seldom do, suggesting that some may be better off in fixed income in order to protect against volatility or principal loss. For these investors there are several options that are still out there that can boost yields back up to respectable levels. Two increasingly popular choices are in the emerging market and junk bond segments. These two sectors often crush the competition in terms of yields and have been opened up to the average investor thanks to ETFs (read Go Local With Emerging Market Bond ETFs).

While either is certainly an intriguing pick, many investors are put-off by the higher risks in the space as junk bonds are more susceptible to defaults (historically) and emerging market bonds tend to see more uncertainty than more stable and developed nations.  Luckily for investors who are seeking yield but are still looking to keep overall risk low in the bond space, there are several choices available at this time (see The Best Bond ETF You Have Never Heard Of). While their yields may not be as high as their emerging market or junk bond counterparts, the payouts are still far higher than comparable Treasury bonds and the risk are much lower than junk bonds. Thanks to this, the following three ETFs could make for a nice middle ground for those investors seeking to stay in bonds but boost current income levels in this yield starved environment:

PowerShares Insured National Muni Bond Fund (PZA)

In the high quality municipal market, yields often times tilt in favor of the Build America Bond (BAB for short) segment. However, when factoring in the tax benefit that comes with tax exempt munis, the picture can shift back to the more traditional corner of the market. In this corner, the highest yielding fund is the PowerShares Insured National Muni Bond Fund (PZA - ETF report) which pays out a TTM distribution yield of about 4.34%. While this might not sound like much, it should be noted that for those in the highest tax bracket the after tax rate is nearly 6.7%, a pretty solid level considering the current environment (read The Forgotten Municipal Bond ETFs).

This fund in particular holds about 184 securities while charging investors just 28 basis points a year in fees after waivers. The product also has a definite tilt towards high quality securities as AA rated notes and above make up nearly 90% of the product, according to S&P. In terms of state allocations, California and Florida are the top two at 15.6% and 13.8%, respectively, while Pennsylvania is the only other state with more than a double digit holding. Investors should note, however, that the product only holds bonds that mature in at least 15 years from now and the average years to maturity is just under 24 years. This suggests that the fund may have a decent amount of interest rate risk although default risk looks to pretty low in this particular case.

SPDR Barclays Capital Long Corp Term Bond Fund (LWC)

In the corporate bond space—not counting junk securities—LWC currently has the highest payout at 4.9% a year. This is accomplished by tracking a broad benchmark of long term—greater than 10 years—sector of the American corporate bond market, holding nearly 425 securities in total. Thanks to this diversification, the fund could be an interesting choice for those seeking high yields but are wary of the muni or broader government market at this time. Plus, since the fund has close to 47% of its assets rated as ‘A’ by an average of the big three and another 43% rated as ‘Baa’, risks look to be a lot lower in this case than in the junk bond market (also read Australia Bond ETF Showdown: AUNZ vs. AUD).

Of LWC’s holdings, the vast majority of towards the ‘industrial’ bond segment, as these securities make up nearly two-thirds of the total assets. To this end, top holdings include AT&T bonds due in 2040, Verizon Communications notes due in 2030, and Wyeth bonds due in 2034. Much like the top holdings, most bonds in this ETF mature from 20-30 years from now, giving the fund an average maturity of roughly 24.2 years. Investors should also note that the product has a monthly distribution frequency and that the gross expenses for the product are pretty low at just 15 basis points a year.

iShares S&P/Citi 1-3 Year International Treasury Bond Fund (ISHG)

In the international market, ISHG offers up the highest payout outside of the emerging market sphere despite its short duration focus. The fund pays out just under 4.5% to investors in TTM distribution terms, while the current 30 Day SEC Yield is even more impressive at 5.3%. Given that the fund has an effective duration of just 1.8 years, the product could be an intriguing alternative for investors looking to broader their bond holdings across borders, but are worried about more volatility in emerging market securities (see The Guide To China Bond ETFs).

ISHG looks to have low volatility thanks to its heavy focus on not just short-term debt, but highly rated fixed income securities. According to Moody’s, 47% of the fund is rated Aaa, while another quarter is Aa3, implying that high quality bonds are an integral part of this fund. From an individual country perspective, Japanese securities dominate, comprising all of the top three individual holdings as well as 22% of the portfolio in total. Beyond these securities, bonds from Italy (8.9%), Germany (8.8%), and France (7.2%), round out the top four, meaning that the product does have a decent tilt to Europe. Thanks to this focus on this troubled region, yields may be a little higher and risks may be a little greater than what some may be expecting in such a short-duration fund. Nevertheless, for those looking for developed market bond exposure across a variety of countries and continents, this product represents a compelling choice.

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