Fixed Income in a Rising Rate Environment

 

Learn how to position your bond holdings as interest rates rise

When economies expand, fixed income investors may become increasingly concerned about rising interest rates and how their bond holdings could be affected. Find out how fixed income investments may respond during a period of economic growth. At the same time, learn which fixed income investments tend to be least impacted in a rising rate environment.
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Bank Loan Funds

Bank loan funds primarily invest in floating-rate bank loans instead of bonds. In exchange for their credit risk, these loans offer high interest payments that typically float above a common short-term benchmark such as the London Interbank Offered Rate (LIBOR).
 

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Emerging Markets Bond Funds

Emerging markets bond funds typically invest more than 65% of their assets in foreign bonds from developing countries. The largest portion of the emerging markets bond market comes from Latin America, followed by Eastern Europe. Africa, the Middle East, and Asia make up the rest.
 

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High-Yield Bond Funds

High-yield bond funds concentrate on lower-quality bonds, which offer the highest yields, but are significantly riskier than bonds of better quality. While they offer high return potential, they are more vulnerable to economic and credit risk.
 

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Inflation-Protected Bond Funds

Inflation-protected bond funds invest primarily in debt securities that adjust their principal values in line with the rate of inflation. These bonds can be issued by any organization, but the U.S. Treasury is currently the largest issuer for these types of securities.
 

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Short Government Funds

Short government funds typically have at least 90% of their bond holdings in bonds backed by the U.S. government or by government-linked agencies. This backing reduces the credit risk of these portfolios, as the U.S. government is unlikely to default on its debt. These portfolios have durations typically between 1.0 and 3.5 years, so they have relatively less sensitivity to interest rates and, thus, low risk potential.
 

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Short-Term Bond Funds

Short-term bond funds invest primarily in corporate and other investment-grade U.S. fixed income issues and typically have durations of 1.0 to 3.5 years. These portfolios may be attractive to fairly conservative investors because they are less sensitive to interest rates than portfolios with longer durations.
 

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Ultrashort Bond Funds

Ultrashort bond funds invest primarily in investment-grade U.S. fixed-income issues and have durations typically of less than one year. This category can include corporate or government ultrashort bond portfolios, but it excludes international, convertible, multisector, and high-yield bond portfolios. Because of their focus on bonds with very short durations, these portfolios offer low interest-rate sensitivity and therefore low risk and total return potential.
 

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World Bond Funds

World bond funds typically invest 40% or more of their assets in foreign bonds. Some world bond portfolios follow a conservative approach, favoring high-quality bonds from developed markets. Others are more adventurous and own some lower-quality bonds from developed or emerging markets. Some portfolios invest exclusively outside the U.S., while others regularly invest in both U.S. and non-U.S. bonds.
 

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Fund selection criteria: The funds displayed are not a recommendation by E*TRADE Securities or its affiliates to buy, sell or hold any security, financial product or instrument nor is it an endorsement of any specific security, company, fund family, product or service. All screens display funds within the respective category and group. All mutual fund screens exclude funds not open to new investors, exclude funds that have expense ratios greater than 2% and only include NLNTF mutual funds with initial investment minimums of $5,000 or less. All ETF screens exclude exchange traded notes and leveraged ETFs. The top performing funds, based on 3 Year total return, within the various category screens are shown in the initial display along with the all the NLNTF All-Star funds of the corresponding category. All funds in the initial display are ranked by 3 Year total return.

All mutual fund screens exclude funds not open to new investors and only include mutual funds with initial investment minimum less than $5,000. All ETF screens exclude exchange traded notes and leveraged ETFs.

All funds within the respective group can be seen by clicking on the hyperlinked / button section in the phrase "X of X results," "See more Mutual Funds," or "See more ETFs."

Floating rate loans generally are subject to restrictions on resale and sometimes trade infrequently in the secondary market. Determining the value of a floating rate loan can be more difficult and buying and selling at an acceptable price can be more difficult or delayed. Difficulty in selling a floating rate loan can result in a loss.

All bonds are subject to interest rate risk and you may lose money. Bonds sold by issuers with lower credit ratings may offer higher yields than bonds issued by higher rated or "investment grade" issuers, but are usually associated with higher risks. High yield bonds, also known as "junk bonds", generally have a greater risk of default, which increases the risk that an issuer may be unable to pay interest and principal on the issue. In addition, high yield bonds tend to have higher interest rate risk and liquidity risk, particularly in volatile market conditions, which makes it more difficult to sell the bonds. Before investing in high yield bonds, you should carefully consider and understand the risks associated with investing in high yield bonds.

Investing outside the United States involves additional risks related to currency fluctuations, economic and political differences and difference in accounting standards.  Investments in emerging or developing markets involve exposure to economic structures that are generally less diverse and mature, and to political systems that can be expected to have less stability than those of more developed countries. These securities may be less liquid and more volatile than investments in U.S. and longer-established non-U.S. markets.

Inflation-protected securities are subject to several general risks, including interest rate risk, credit risk, market risk and inflation-protected securities risk. Interest payments on inflation-protected securities will vary as the principal and/or interest is adjusted for inflation and may be more volatile than interest paid on ordinary fixed income securities.

Government-backed bonds only applies to the timely payment of principal and interest of the underlying securities and does not apply to fund shares.

International investing carries certain risks that can be different from the risks of U.S. investments. These risks can include political or economical instability, changing currency rates, foreign taxes, reduced liquidity (difficulty selling securities held by a fund) and different regulatory or financial accounting standards.

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The Morningstar RatingTM for funds is calculated for management investment company products registered under the Investment Company Act of 1940 (including mutual funds, exchange-traded funds and closed-end funds) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are analyzed as a single product category for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star.

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All-Star Funds typically have at least a three year track record and compare favorably against their peers based on historical return, risk, expenses, manager tenure, performance and style consistency, asset size and growth and must be 1) structured through sound investment philosophy and process, 2) implemented with acceptable level of investment risk management strategy and 3) supported by a reputable investment firm. To view the fund's Report Card with additional performance metrics, including standardized quarterly results, please click on the fund name.

Expense ratios are provided by Morningstar and are based on information obtained from the ETFs last audited financial statement. Current expense ratios for the ETFs may be different.

Yield is a measure of the fund's income distributions, as a percentage of the fund price. Morningstar calculates this figure by summing the income distributions over the trailing 12 months and dividing that by the sum of the last month's ending NAV plus any capital gains distributed over the 12-month period.

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International Exchange-Traded Funds and mutual funds offer an easy way to participate in foreign markets. They generally provide broad diversification and will handle complicated issues, such as foreign tax payments and currency conversions, on behalf of investors.

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