The rise 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 have fallen and inflation has encouraged higher payouts. This has created a huge appetite for short-duration ETFs, giving investors easier access to what is now the most lucrative part of the bond market. Some of the funds collect money from investors. The JPMorgan Ultra-Short Income ETF has raised more than $3.5 billion in new money this year. The SPDR Bloomberg 1-3 Month T-Bill ETF has attracted more than $7 billion in inflows and the iShares Short Treasury Bond ETF has been inundated with nearly $10 billion in new funds. These flows have been chasing solid performance as longer-dated bond portfolios have been hurt by rising interest rates. The JPMorgan fund, for example, is almost flat for the year on a price basis, while its monthly payout has more than tripled since December. Source: FactSet; September 15 return dates The space is also attracting new entrants. AllianceBernstein launched its first ETFs last Wednesday, including the AB Ultra Short Income ETF, a fund that invests in debt securities with a maturity of less than a year. Noel Archard, the company’s global head of ETFs, said that in February, AllianceBernstein decided to add these funds to its first ETF offering. “Realistically, we’ve said this will most likely be a volatile year, with maybe some potential for rate hikes,” Archard said. That looks predictive now. With the Fed expected to announce another big rate hike on Wednesday and traders growing concerned about a global recession, short-dated fixed income could be an attractive trade for the foreseeable future. Further inversion risk “We believe two trends will continue to dominate bond markets into 2023: a flat to inverted yield curve and increased volatility. The faster and more vigorous the pace of Fed rate hikes, the greater the risk of recession and the more likely the yield curve will continue to invert,” wrote Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research, last week. An inverted yield curve refers to short-term yields that are higher than longer-term yields. For example, the 1-year Treasury bill returned almost 4% on Friday versus 3.45% for a 10-year Treasury bill. The combination of rapidly rising interest rates and an inverted yield curve creates a number of advantages for short-duration funds. For one, with near-4% short-term Treasury yields, investors can earn a risk-free return that far exceeds the 1.6% yield of the S&P 500 and also many longer-dated fixed-income instruments. Short-term funds also limit reinvestment risk. If yields stay high for longer, short-term funds can reinvest payments and capital from maturing paper into new, higher-yielding issues. However, for funds holding 10-year products, the market value of their assets would simply decline while their coupon payments become relatively less attractive. Notable Differences Many of these funds have differences that investors should be aware of. Those that deal in corporate bonds or even foreign government bonds carry a higher risk than pure US Treasury bonds. Municipal debt, which has tax benefits relative to other fixed income sources, has other folds that can impact fund performance. 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-duration municipal bonds, but has the flexibility to look elsewhere when tax-advantaged municipal bonds are an option relatively unattractive. If the fund sees Treasuries’ after-tax yields “looking more attractive than AAA munis with a comparable duration, then we might pick them up just for the yield hike,” Archard said. AllianceBernstein’s municipal ETF has a management fee of 0.27%, while the ultra-short income fund’s fee is 0.25%.