FBND: Investors Should Be Accumulating This 5%-Yielding Bond Fund Before Rate Cuts

Fidelity Total Bond ETF (NYSEARCA:FBND) invests in a wide variety of bonds which includes high-yield, investment grade and emerging market bonds. It invests up to 20% of its assets in lower quality bonds, in order to capture yield and also to fulfill the goal of being a “total” bond fund. It invests in a range of maturities as well. This bond ETF offers investors a generous yield, and a chance to hold one investment that gives them exposure to the wide range of options in the bond market. Let’s take a closer look:

Portfolio Characteristics To Consider

This fund was started on October 6, 2014, and it has over 3,600 holdings in the portfolio, with about $8 billion in assets. It is actively managed and has an expense ratio of 0.36%. The weighted average maturity is 8.5 years and it has a current SEC yield of 5.13%. This yield competes with the current rates offered by money market funds, but the difference is that money market fund rates could be poised to plunge over the next couple of years, which means this ETF could be poised to reward investors with the over 5% yield but also potentially with capital gains. This fund has a 4 star rating from Morningstar, for its 3-year and 5-year performance. As shown below, the vast majority of this fund is invested in Investment Grade Bonds, and the reason there is a negative cash balance is because the fund is using a small amount of leverage which can magnify gains or losses.

Investment Grade Bonds: 89.16%

High Yield Bonds: 11.6%

Emerging Markets: 2.8%

Cash, and Equivalents: -3.56%

The Chart

As the chart below shows, this ETF traded down to the low $40 level in October, 2023. In early 2024, it rallied beyond the $45 level, but there has been a small pullback recently. The 50-day moving average is $44.62 and the 200-day moving average is $43.81. It’s also worth noting that at the very end of 2023, a bullish “Golden Cross” formation appeared on the chart when the 50-day moving average crossed over the 200-day moving average.

Signs Of Weakness In The U.S. Economy Suggests Rate Cuts Are Coming

Recent reports show the U.S. economy is starting to weaken. For example, in the first quarter of 2024, the Gross Domestic Product or “GDP” grew at a rate of only 1.6%. This is a significant (50%) drop from the 3.4% rate of GDP growth in the same quarter last year. It appears that some consumers are cutting back on what is even an affordable luxury for many people, and that is coffee and other beverages at Starbucks (SBUX) which reported a drop in revenues for Q2 2024 results. Starbucks said some consumers were becoming more cautious.

Adding more concern about a potential slowdown for the U.S. economy was the April unemployment report which showed fewer jobs were added compared to expectations and unemployment had ticked up. This shows a potential shift in momentum in the jobs market and future reports could show accelerated weakness. While many investors seem to believe in a soft landing, I believe the Federal Reserve is always looking in the rear-view mirror rather than what is up ahead. Not too long ago, the Federal Reserve was calling inflation “transitory” as it kept rates lower for longer. Now they are talking about higher for longer and in doing so they are looking at data that is not necessarily indicative of what is to come in terms of the future.

Even if the Federal Reserve keeps rates higher for a few more months, it seems to just be delaying the inevitable because the data is either going to start getting much worse soon and that will force the rate cuts, or the Federal Reserve will decide to ease soon in order to reduce the chance of a hard-landing recession.

Earlier this year, the Federal Reserve released projections that indicate a 2.25 point drop in the Fed Funds rate could be coming by the end of 2026. This could reduce the Fed funds target rate from the current range of 5.25% to 5.5%, to a range of 3% to 3.25%, in the next couple of years. This would be a 40% decline in interest rates between now and 2026. That type of decline could spark a major rally in bonds and create capital gains for investors in this ETF. This is why I think it is important to start moving cash out of money market funds and into the bond market. A recent CNBC article points out that analysts at BlackRock (BLK), believe it is time for investors to buy bonds, in particular because they are underweight in fixed income, the article states:

“In fact, many investors are currently significantly underweight to fixed income. They have just a 19% average allocation to the asset class, according to the BlackRock report, which analyzed Morningstar’s data of U.S. bond and money market exchange-traded funds and mutual fund assets as of Jan. 31.

“It is a very compelling opportunity for investors to get their fixed-income side of the portfolio right sized,” Laipply said.”

Potential Downside Risks

There is some increased default risk in some sectors of the bond market, which includes high-yield and emerging market bonds. However, default rates remain very low, at least for now.

There is also duration and interest rate risk, particularly with longer duration bonds, and this could present downside risks if interest rates were to keep rising. One thing that helps mitigate the downside with bonds, is the yield. This often means that if bond values decline, you might still be able to breakeven in a relatively short time thanks to the monthly dividend payout.

In Summary

Too many investors are complacently parking cash in money market funds which currently yield over 5%. That is a great yield, but unfortunately it is not likely to last, and the yields on money market accounts tend to drop very quickly as rates drop. Based on the plans the Federal Reserve has outlined, money market fund yields could be close to 3% in 2026. That is why I think it makes sense to accumulate this ETF on pullbacks now. I will buy more aggressively if this fund trades back down to the 200-day moving average which is near $44. With this bond fund, it is possible to lock in a yield above 5%, and in doing so, it could position a portfolio for capital gains.

No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.