The improbability of impending interest rate cuts by the Federal Reserve and the rising risk of further rating downgrades of banks could exacerbate the ongoing market volatility in the foreseeable future.

Amid an uncertain macroeconomic environment, top-performing intermediate-term bond ETFs Vanguard Total Bond Market Index Fund (BND), First Trust Low Duration Opportunities ETF (LMBS), and iShares Core 1-5 Year USD Bond ETF (ISTB) emerge as ideal portfolio additions, offering instant diversification and stable returns.

In July, the Fed lifted interest rates, taking the benchmark interest rate between 5.25% and 5.50%, its peak in 22 years. Yet, Chairman Jerome Powell did not commit to a further rate increase, leaving this choice contingent on forthcoming economic data ahead of the subsequent FOMC meeting.

The 3.5% decline in the U.S. unemployment rate in July and a 2.4% annualized surge in the second quarter’s gross domestic product indicate firm economic stature. Consequently, Jerome Powell and his team may be on the brink of accomplishing the “soft landing.”

Coinciding with these developments, the consumer price index (CPI) rose 3.2% year-over-year in July, slightly below the 3.3% estimate but higher than in June, instilling the belief that further rate hikes might not materialize. Inflation has considerably retreated from its 40-year highs experienced in mid-2022 but persists notably above the Fed’s 2% threshold. Therefore, interest rate reductions seem unlikely this year.

Fitch Ratings brought shock and uncertainty to the financial landscape by downgrading the United States’ sovereign credit rating from AAA to AA+. Concurrently, Moody’s also cut the credit ratings of 10 U.S. banks and alerted major lenders of possible downgrades, intensifying the existing market instability.

Though these downgrades have muddled investor sentiment toward Treasury debt to a degree, heightened expectations of enduring elevated rates have been sparked by the revelation in the central bank’s July meeting minutes, potentially calling for additional rate hikes. This has pushed bond yields to the highest levels in over a decade. Also, higher Treasury yields, backed by the U.S. government, are regarded as relatively risk-free.

Given the current market scenario, investors may find comfort in bond ETFs spanning short-term, intermediate-term, or long-term maturity ranges. These fixed-income ETFs provide immediate portfolio diversification across and within the bond segment of the portfolio. Additionally, most bond ETFs distribute dividends, offering investors consistent income within a short timeframe.

Therefore, investments in quality intermediate-term bond ETFs BND, LMBS, and ISTB seem prudent.

Vanguard Total Bond Market Index Fund (BND)

BND is an exchange-traded fund launched and managed by The Vanguard Group, Inc. The fund invests in investment-grade debt securities, including government, corporate, international dollar-denominated bonds, and mortgage-backed and asset-backed securities. It seeks to track the performance of the Bloomberg U.S. Aggregate Float Adjusted Index.

As of August 21, BND had $93.74 billion in assets under management (AUM) and a Net Asset Value (NAV) of $70.52. Its net inflows were $15.79 billion over the past year and $4.62 billion over the past three months. In addition, its 0.03% expense ratio is lower than the 0.41% category average.

BND’s top holdings include U.S. Dollar, with a 0.84% weighting; United States Treasury Notes at 0.75%, due April 30, 2026, with a 0.60% weighting; and United States Treasury Notes at 4.125%, due November 15, 2032, with a 0.58% weighting. It has a total of 10,591 holdings currently.

BND pays a $2.08 annual dividend, which yields 2.93% at the prevailing price. Its four-year average dividend yield stands at 2.48%.

BND’s fund has lost marginally intraday to close the last trading session at $70.53.

BND’s solid fundamentals are reflected in its POWR Ratings. It has an overall B rating, which equates to a Buy in our proprietary rating system. The POWR Ratings are calculated considering 118 different factors, with each factor weighted to an optimal degree.

BND has an A grade for Buy & Hold. It is ranked #11 out of 50 ETFs in the B-rated Intermediate-Term Bond ETFs group.

To see all the BND’s ratings for Peer and Trade, click here.

First Trust Low Duration Opportunities ETF (LMBS)

LMBS is an actively managed mortgage-backed securities (MBS) ETF with a duration target and reaches beyond agency-backed MBS to include non-agency and commercial MBS for relative value and yield. The fund primarily seeks to generate current income with a secondary objective of capital appreciation.

As of August 21, 2023, LMBS has an AUM of $4.23 billion and a NAV of $47.56. Its net inflows came at $3.14 billion over the past five years. In addition, its 0.66% expense ratio. Also, it has a five-year beta of 0.31.

The fund’s top holdings include Fannie Mae or Freddie Mac TBA, 5.50%, due June 1, 2053, with a 3.69% weighting; Freddie Mac TBA, 5%, due June 1, 2053, with a 2.67% weighting; Freddie Mac TBA, 4%, due August 1, 2052, with a 2.24% weighting; and Fannie Mae FN FM3003, 4%, due May 01, 2049, with a 2.07% weighting. It has a total of 1,185 holdings currently.

In July, LMBS declared a monthly dividend of $0.15 per share, an 11.1% increase from the previous dividend of $0.135. The dividend was paid on July 31 to shareholders. The fund’s annual dividend of $1.47 yields 3.17% on the current share price. Its four-year average yield is 2.29%. Its dividend payouts have increased at a CAGR of 45.3% over the past three years.

The fund has lost marginally intraday to close the last trading session at $47.42.

LMBS’ POWR Ratings reflect this promising outlook. The fund’s overall B rating equates to a Buy in our proprietary rating system.

LMBS has an A grade for Buy & Hold and a B for Peer and Trade. Within the same group, it is ranked #18.

One can access all the LMBS ratings here.

iShares Core 1-5 Year USD Bond ETF (ISTB)

ISTB provides exposure to short-term U.S. dollar-denominated bonds that are rated either investment grade or high yield with remaining maturities between one and five years. This fund covers a broad spectrum of U.S. dollar-denominated fixed-income instruments, including U.S. Treasurys, government-related issues, MBS, CMBS, Eurodollar bonds, and high-yield corporate bonds.

As of August 21, ISTB had $4.14 billion in AUM and a NAV of $46.38. Its net inflows came at $471.46 million over the past three years. In addition, its 0.06% expense ratio is lower than the 0.41% category average. Also, it has a five-year beta of 0.46.

ISTB tracks the performance of the Bloomberg U.S. Universal 1-5 Year Index. ISTB’s top holdings include U.S. Treasury Notes at 1.25%, due November 30, 2026, with a 1.37% weighting; U.S. Treasury Notes at 0.875%, due September 30, 2026, with a 1.27% weighting; and followed by U.S. Treasury Notes 4%, due February 29, 2028, with a 1.03% weighting. ISTB currently has 5,385 holdings in total.

Its annual dividend of $1.22 translates to a 2.62% yield on the current share price. The fund’s four-year average yield is 2.17%.

The fund has lost marginally intraday to close the last trading session at $46.39.

ISTB’s fundamental strength is reflected in its POWR Ratings. The ETF has an overall rating of A, translating to a Strong Buy in our proprietary rating system.

ISTB has a grade A for Trade and Buy & Hold. It also has a B grade for Peer. It is ranked first within the same group.

Click here to access all the ISTB ratings.

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BND shares were trading at $70.58 per share on Tuesday morning, up $0.05 (+0.07%). Year-to-date, BND has declined -0.04%, versus a 15.96% rise in the benchmark S&P 500 index during the same period.

About the Author: Sristi Suman Jayaswal

The stock market dynamics sparked Sristi's interest during her school days, which led her to become a financial journalist. Investing in undervalued stocks with solid long-term growth prospects is her preferred strategy. Having earned a master's degree in Accounting and Finance, Sristi hopes to deepen her investment research experience and better guide investors. More...

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