The rise in interest rates this year, especially at the short end of the yield curve, has given income investors an attractive place to put their money as stocks fall and inflation hits. Inflation adds value to larger payments. That has created a huge appetite for short-term ETFs, giving investors easier access to what has become the most lucrative part of the bond market. Some funds are making money from investors. The JPMorgan Ultra Short Income ETF has raised more than $3.5 billion in new money this year. SPDR Bloomberg 1-3 Months T-Bill ETF attracted more than $7 billion in inflows, and the iShares Short-Term Treasury Bond ETF received nearly $10 billion in new money. Those outflows have pursued solid performance, as portfolios of older bonds have been hit by rising interest rates. For example, the JPMorgan fund has been roughly flat for the year on a price basis, while its monthly distribution has more than tripled since December. Source: FactSet; returns data as of 9/15 The space is also attracting new entrants. AllianceBerntein launched its first ETFs last Wednesday, including the AB Ultra Short Income ETF, a fund that invests in debt with a maturity of less than a year. Noel Arcard, the company’s global head of ETFs, said that AllianceBerntein decided in February to include these funds in their first list of ETF offerings. “We’ve said, in fact, that this will most likely be a volatile year, possibly with some possibility of rate hikes,” Archard said. That seems to have been known in advance. With the Fed expected to announce another big rate hike on Wednesday and traders growing increasingly concerned about a global recession, near-term fixed income could be an attractive trade. lead in the near future. Risk of further reversal “We believe two trends will continue to dominate the bond market into 2023: flat to inverted yield curve and high volatility. Rate of interest rate hikes The faster and stronger the Fed, the higher the recession risk and the more likely it is that the yield curve will invert further,” said Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research, wrote last week. An inverted yield curve refers to a higher short-term yield than a long-term yield. For example, the one-year Treasury note yielded nearly 4% on Friday compared with 3.45% for the 10-year Treasury note. The combination of rapidly rising interest rates and an inverted yield curve creates a number of 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% yield on the S&P 500, and also as high than many older fixed income instruments. Short-term capital also limits reinvestment risk. If yields stay higher over the long term, short-term funds will be able to reinvest payments and principal from maturing paper into new, higher-yielding issues. However, funds that hold 10-year products will simply see the market value of their assets decline while their coupon payouts become relatively less attractive. Notable Differences There are differences between many of these funds that investors should be aware of. Corporate loans or even foreign government bonds carry more risk than funds destined for US Treasuries. Municipal debt, which has a tax advantage over other sources of fixed income, presents other wrinkles that can affect the fund’s performance. For example, another new AllianceBerntein 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 search where other if local government debt is tax preferential. relatively unattractive. If the fund finds the Pearurys’ after-tax return “looks more attractive than the AAA cars of the same age, then we can go and pick it up just for the profit,” Arcard said. AllianceBerntein’s city ETF has a management fee of 0.27%, while the fee for the ultra-short-income fund is 0.25%.