If you haven't already been looking at fixed-income ETFS, chances are you will be in the near future. Stocks remain turbulent and we're seeing all sorts of rhetoric extolling the benefits of diversifying with fixed income. And with ETFs so easy to trade and track, this seems to be turning into the preferred way to get it done. Robo-advisers are taking that to heart: Unless your answers to their brief electronic questionnaires portray you as a bold gunslinger, you're likely to have substantial exposure to fixed-income ETFs. But this may be an area in which ease kills.
Why Fixed Income
This is easy to understand. Fixed income entails lower risk than stocks and is, therefore, less volatile. So it's served investors well for many years as a way to diversify portfolios.
Why Fixed-Income ETFs
They're easy to trade and track because they feel and act in this regard just like stocks. With ETFs, we don't have to hunt for bonds nor do we have to deal with the un-stock like mechanics of contributing to or redeeming interests in open-end mutual funds. Indeed, fixed-income ETFs have becomes staples among the robo-advisors, which pride themselves in convenience.
Why You Can Get Burned in Fixed Income
Do I really have to go into detail on how low interest rates are, and how (aside from trivial downward squiggles now and then) we're looking at stagnation as a best-case scenario or more likely, eventual rate gains, which would hurt fixed income. Bank of England Chief Economist Andy Haldane puts this into perspective by pointing out that rates now are lower even than they were at any time since 3000 B.C.E. That means all those graphs and charts showing you how wonderful fixed-income diversification are now of value primarily for what they can fetch on EBay as collectables, right along side rotary-dial telephones.
Why You Can Get Especially Burned in Fixed Income ETFs
Consider the iShares 20+ Year Treasury Bond ETF (TLT). Its weighted average maturity is 26.7 years and its weighted average duration is 18.6 years. If you don't know bond math, consider it the fixed income equivalent of equity beta above 2.00. In other words, it's not merely volatile. It's VOLATILE!
That alone should scare you given the prospect of rising interests. Saying they aren't rising today doesn't really help much. Even if rates start rising two years from now (most seem to think it won't take nearly that long), the holder of TLT would still be akin to someone guaranteed to be burned at the stake two years from now. Yeah it doesn't hurt today. But is the “present value” of assured agony two years hence really such a good thing? Why not simply avoid the fate altogether, even if escape from the situation means forfeiting some luxurious fine meals between now and then.
