An ultra-short bond fund is a bond fund that invests in fixed-income instruments with very short-term maturities, typically less than one year. Due to their focus on short durations, these portfolios offer minimal interest-rate sensitivity, reducing risk and potential return. These funds often provide higher yields than money market instruments and exhibit fewer price fluctuations than typical short-term funds.
Ultra-short bond funds should not be confused with bear bond funds or ETFs that go short bonds on a leveraged basis.
Key Takeaways
- Ultra-short funds hold short-term fixed-income securities, maturing in less than one year.
- These funds have more flexibility and typically chase higher yields by investing in riskier securities than traditional bond funds.
- The FDIC does not cover or guarantee ultra-short bond funds.
- In environments with high-interest rates, certain types of ultra-short bond funds may be more susceptible to losses.
Enhanced Security with Ultra-Short Bond Funds
Ultra-short bond funds provide significant protection against interest rate risk compared to longer-term bonds. Because of their low durations, increases in interest rates have less impact on these funds compared to medium- or long-term bond funds.
While providing better protection against rising interest rates, ultra-short bond funds often carry more risk than most money market instruments. Unlike regulated CDs, ultra-short bond funds provide no more regulatory oversight than standard fixed-income funds.
Comparing Ultra-Short Bond Funds to Other Low-Risk Investments
It’s important to understand the differences between ultra-short bond funds and other low-risk investments, such as money market funds and certificates of deposit (CDs).
Money market funds invest in high-quality, short-term securities issued by the U.S. government, corporations, and state and local governments. In contrast, ultra-short funds often seek higher yields by investing in riskier securities, and their NAVs can fluctuate. While money market funds strive to keep their NAV stable at $1.00 per share and follow strict diversification and maturity standards, these regulations don’t apply to ultra-short bond funds.
The FDIC does not insure ultra-short bond funds. CDs, however, are insured up to $250,000 and guarantee a return of the principal plus a specified interest rate, provided the deposit is held by an insured bank or thrift institution. Despite offering better interest rates than regular savings accounts, terms, and conditions apply depending on each bank’s policies. Ultra-short bond funds investing in bonds with longer average maturity dates are generally riskier than those with shorter dates under the same set of conditions.
Evaluating the Credit Quality of Ultra-Short Bond Funds
Evaluating the credit quality of the securities in an ultra-short bond fund is crucial since a credit downgrade or default can result in losses. Because short-term bonds mature quickly, credit risk is less significant for these funds compared to traditional bond funds. Credit risk is further reduced if the fund predominantly invests in government securities.
Nonetheless, watch for funds investing in lower-credit-rated corporate bonds, derivative securities, or private-label mortgage-backed assets, as they often carry increased risks. Always apply caution with investments that promise greater returns with no added risk. Comprehensive reading of the fund’s available information, including its prospectus, is advisable to make informed decisions.
Ultra-Short Bond Funds in High-Interest Rate Environments
In high-interest rate environments, certain types of ultra-short bond funds are more prone to losses. Prospective investors should closely research a fund’s duration to understand its sensitivity to interest rate changes.
Examples of Ultra-Short Bond Funds
Here are some well-performing ultra-short bond funds to consider:
- SPDR Bloomberg Barclays Investment Grade Floating Rate ETF (FLRN)
- iShares Floating Rate Bond ETF (FLOT)
- VanEck Vectors Investment Grade Floating Rate ETF (FLTR)
- iShares Short Treasury Bond ETF (SHV)
- SPDR® Bloomberg Barclays 1-3 Month T-Bill ETF (BIL)
Related Terms: Maturities, Duration, Money Market Instruments, Bear Bond Fund, Interest Rate Risk, Net Asset Values (NAV), Credit Risk, Prospectus.
