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4 Bond ETFs to Play If Rates Rise

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Rising rate worries could be starting to bother both equity and bond markets. Two Federal Reserve officials recently said that the U.S. economy is advancing steadily. Though the labor market still has room for improvement, inflation is running high and may compel the Fed to taper QE.

Atlanta Federal Reserve Bank President Raphael Bostic said he is eyeing the fourth quarter for the start of a bond-purchase taper but can support an even earlier start if the job market records faster improvement. Moreover, both Bostic and Richmond Fed President Tom Barkin believe that inflation has already hit the Fed's 2% goal, according to their separate assessments, as quoted on the source. And this is where the Fed could rely on for policy tightening.

Such rising rate worries have similarities with the taper tantrum we noticed in 2013. Back then, the selloff was triggered by the Fed’s decision to wrap up the QE measure in a phased manner. Back then, the U.S. 10-year Treasury yields had jumped from 1.60% to about 3% on the same fear.

U.S. benchmark Treasury yields started the month with 1.20% while it ended Aug 10 at 1.36%. If QE taper starts, there could be a rout in the bond market.

iShares 20+ Year Treasury Bond ETF (TLT - Free Report) lost about 0.5% on Aug 10. No wonder, in the face of rising bond yields, investors might be fearing fixed-income investing as yields and bond prices are inversely related.

But there are fixed income ways that would help investors mitigate such threats yet prove profitable. Below we highlight a few of them:

ETFs in Focus 

iShares Floating Rate Bond ETF (FLOT - Free Report)

Floating rate notes are investment grade bonds that do not pay a fixed rate to investors but have variable coupon rates that are often tied to an underlying index (such as LIBOR) plus a variable spread depending on the credit risk of issuers.

Since the coupons of these bonds are adjusted periodically, they are less sensitive to an increase in rates compared to traditional bonds. FLOT has an effective duration of 0.10 years and thus presents minimal interest rate risks.

Highland/iBoxx Senior Loan ETF (SNLN - Free Report)

Senior loans are issued by companies with below investment grade credit ratings. In order to make up for this high risk, senior loans normally have higher yields. Since these securities are senior to other forms of debt or equity, these give protection to investors in any event of liquidation. As a result, default risk is low for such bonds, even after belonging to the junk bond space.

Senior loans are floating rate instruments and provide protection from rising interest rates. In a nutshell, a relatively high-yield opportunity coupled with protection from the looming rise in interest rates should help the fund to perform better. SNLN could thus be a good pick for the upcoming plays. It yields around 2.18% annually.

Vanguard Short-Term Bond ETF (BSV - Free Report)

Higher rates might lead to huge losses for investors who do not hold bonds until maturity. As a result, a short-duration bond ETF like BSV acts as a better hedge to rising rates. U.S. government bonds take about 66.95% of the fund.  The average maturity and effective duration are 2.8 years and 2.9 years, respectively. It charges 5 bps in annual fees.

The WisdomTree Interest Rate Hedged U.S. Aggregate Bond Fund (AGZD - Free Report)

The underlying Bloomberg Barclays Rate Hedged U.S. Aggregate Bond Index, Zero Duration seeks to combine exposure to the Barclays US Aggregate Bond Index with a structured interest rate overlay to target a duration of zero years. Such technique of interest-rate hedging makes the fund well positioned to play in a rising rate environment. The fund charges 23 bps in fees and yields 1.88% annually.