The increase in interest rates this year, particularly at the short end of the yield curve, has given income investors an attractive place to put their money as stocks are low and inflation puts a premium on larger payments. This has created a huge appetite for short-term ETFs, which give investors easier access to the more lucrative part of the bond market. Many funds earn cash from investors. Ultra-short-earth income JPMorgan pulled more than $3.5 billion in new money this year. SPDR Bloomberg’s 1-3 month T-Bill ETF attracted more than $7 billion in inflows, and the iShares Short Treasury Bond ETF was flooded with nearly $10 billion in new money. These inflows have chased the strong performance, as long-term bond portfolios have been hit by higher interest rates. JPMorgan’s fund, for example, is roughly flat for the year on a price basis, while its monthly distribution has more than tripled since December. Source: FactSet; Returning data as of 9/15 The space attracts new participants as well. AllianceBernstein launched its first exchange-traded funds last Wednesday, including the AB Ultra Short Income ETF, a debt-invested fund with less than one year to maturity. Noel Archard, the company’s global head of ETFs, said AllianceBernstein decided in February to include these funds among its first ETF offerings. “Realistically, we’ve been saying this is likely going to be a volatile year, with some rate increases likely,” Archard said. Seems to be insight now. With the Federal Reserve expected to announce another significant rate hike on Wednesday, and traders increasingly concerned about a global recession, short-term fixed income could be an attractive trade for the foreseeable future. More reversal risks “We believe two trends will continue to dominate bond markets through 2023: a flat to inverted yield curve and increased volatility. The faster and more aggressive the pace of Fed rate hikes, the higher the risks of a recession and the more likely the yield curve will invert,” he said. Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research, wrote last week. An inverted yield curve indicates higher short-term returns than long-term returns. For example, a one-year Treasury bond yields nearly 4% on Friday versus 3.45% for a 10-year Treasury bond. The combination of rapidly increasing interest rates and an inverted yield curve creates some benefits for short-term funds. First, with short-term treasury yields approaching 4%, investors can get a much higher risk-free return than the 1.6% return on the S&P 500, and also higher than many long-term fixed income instruments. Short-term funds also reduce reinvestment risk. If the returns remain higher for a longer period, the short-term funds will be able to reinvest the payments and money from the maturity of the papers into new higher-yielding issues. However, funds with 10-year products will simply see the market value of their assets decline while coupon payments become relatively less attractive. Notable Differences There are differences between many of these funds that investors should be aware of. Those who engage in corporate debt or even foreign government bonds carry more risk than just US Treasury funds. Municipal debt, which has tax advantages over other sources of fixed income, presents other wrinkles that may affect the performance of the fund. For example, another new AllianceBernstein fund is the AB Tax-Aware Short Duration Municipal ETF, which will always hold at least 80% of its assets in short-term municipal bonds but has the flexibility to look elsewhere if tax-privileged local government debt appears to be unsustainable. Relatively attractive. If the fund were to see Trarise’s after-tax yield “seem more attractive than AAA bonds of similar duration, we might choose that just for the sake of increasing the yield,” Archard said. The management fee for the AllianceBernstein domestic ETF is 0.27%, while the fee for the ultrashort income fund is 0.25%.