Adding Caution to the Kiplinger ETF 20

Fund Watch

Adding Caution to the Kiplinger ETF 20

We've traded VanEck Vectors Fallen Angels High Yield for iShares Ultra Short-Term Bond to tamp down risk among our favorite exchange-traded funds.

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As the specter of an economic slowdown and eventual recession looms, we’re making a defensive shift in our Kiplinger ETF 20 roster (the collection of our favorite exchange-traded funds for a well-rounded portfolio), swapping VanEck Vectors Fallen Angels High Yield (ANGL for iShares Ultra Short-Term Bond ETF (ICSH).

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Vectors Fallen Angels High Yield holds bonds issued by firms that once fetched investment-grade credit ratings but have since “fallen” to lower-rated “junk” status because of weak balance sheets, poor management or other troubles. (Junk bonds have a greater risk of default compared with investment-grade debt.) In other words, the ETF invests in bonds the credit-rating agencies once regarded as safe but now consider speculative.

In good times, Vectors Fallen Angels High Yield soared. It returned 25.7% in 2016 and 9.4% in 2017, beating most of its peers in both years. But over the past year, the fund has lost 2.7%, trailing 94% of its high-yield ETF peers. Indeed, if the economy has seen its best days (for the current cycle), a move to higher-quality bonds is prudent. “Given where we are in the current market, it’s a good idea to build into your bond portfolio some resiliency, more diversification and more high-quality debt,” says Jonathan Rather, a member of the fixed-income strategy team at investment firm BlackRock.

That brings us to iShares Ultra Short-Term Bond, an actively managed fund that offers a mix of high-quality bonds with one- to three-year maturities. Roughly 82% of the port­folio—a mix of short-term corporate notes, investment-grade floating-rate bonds and some certificates of deposit—is rated single-A or better. (Investment-grade ratings start at triple-B and go up to triple-A.) What’s more, the fund has a low, 0.39-year duration (a measure of interest-rate sensitivity). That means if rates were to rise by one percentage point, the fund’s net asset value would fall 0.39% (yields and prices move in opposite directions). The broad bond market index, Bloomberg Barclays U.S. Aggregate Bond, has a duration of nearly six years.

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The iShares fund has recently shown how resilient it can be. Over the past 12 months, as the Agg index struggled to stay in positive territory, Ultra Short-Term Bond gained 2.3%. The ETF even beat the 1.6% return of Pimco Enhanced Low Duration Active (LDUR), a Kip 20 ETF we added last year as a hedge against rising interest rates.

What’s the difference between iShares Ultra Short-Term Bond and Pimco Enhanced Low Duration? An investment in either would be considered a defensive move, but the iShares ETF portfolio is an even more cautious play, thanks to its higher-quality portfolio. Ultra Short-Term holds only investment-grade debt; 10% of the Pimco fund is junk-rated or unrated. The trade-off, of course, is yield. The Pimco ETF yields 3.7%; the iShares offering, 3.0%. We think there’s room for both in your portfolio.

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