You can earn good yields with very low price risk in ultrashort bond funds
Risk-averse investors seeking more income than they can get with a money-market fund should consider ultrashort bond funds.
At a time when interest rates are rising quickly, there is no end of frightening headlines about how bond prices are falling at the same time, offsetting the benefit of the increased income. While interest rates can still soar from here, one way to avoid most of the price risk is with ultrashort bond funds.
If you invest in an individual bond, you can hold it until it matures or until it is called and be paid its face value. But investors in bond funds face day-to-day price volatility risk. A bond fund has a fluctuating share price, and if you are going through a long cycle of rising interest rates, you can have negative total returns (price action plus reinvested dividends) for years.
The action: Investors see big opportunity in ferocious 2026 bond-market rout
At the moment, investors are looking at a normal yield curve, which means higher yields for committing to longer periods. Two years ago, the yield curve was inverted, with 3-month U.S. Treasury bills BX:TMUBMUSD03M yielding 4.77%, while 10-year Treasury notes BX:TMUBMUSD10Y yielded only 4.03%.
Here are what several Treasury maturities were yielding early Wednesday. You can click on the tickers for the latest yield quotes.
U.S. Treasury security Yield early on Oct. 7, 2026 3-month 4.14% 1-year 4.44% 2-year 4.81% 3-year 4.94% 5-year 5.05% 10-year 5.31%
For income-seeking investors who want to take no price risk, money-market funds have share prices that are fixed at a dollar, and if you shop around in this market you can find some attractive yields, such as the Schwab Prime Advantage Money Fund, which quotes a seven-day yield of 3.70%.
Long-term bond rates were pushed up dramatically as the bond market sold off in anticipation of the Federal Open Market Committee's decision on Sept. 16 to increase the federal-funds rate by 0.25% to its current target range of 3.75% to 4%.
'Nobody is going to predict interest rates.'Laura Mayfield, senior portfolio manager for securitized products, Fort Washington Investment Advisors
When asked if possible further moves by the Fed might affect her investment decisions, Laura Mayfield, who manages the Touchstone Ultra Short Income Fund TUSI, said, "The market is pricing in a hold in October and another hike in December." She added: "Nobody is going to predict interest rates. The way to manage this portfolio is through diversification."
This is where it can be very helpful to look at total returns for different types of bond funds. These are one-year total returns, with dividends reinvested, for the Vanguard Intermediate-Term Treasury ETF VGIT and two ultrashort bond exchange-traded funds for one year through Tuesday:
Ultrashort bond funds have lower yields, but their low price volatility has made for positive one-year total returns, while intermediate and long-term bond funds have tended to have negative one-year returns.
'We expect positive returns for ultrashort even if rates continue to rise.'Joanne Driscoll, head of short-term liquid markets at Franklin Templeton Fixed Income
Right now the Vanguard Intermediate-Term Treasury ETF quotes an SEC 30-day yield of 4.98%, while the Franklin Ultra Short Bond ETF FLUD quotes a 30-day yield of 4.18% and the TUSI 30-day yield is 4.43%.
But for one year through Tuesday, VIGT's share price declined 5.4%, while FLUD's price declined 0.6% and TUSI's price declined 0.5%.
During an interview with MarketWatch, Mayfield said investors in the ultrashort bond space have "a risk appetite similar to what a cash investor's would be, but they do want additional yield."
VGIT's average duration is 4.9 years, while its average effective maturity is 5.6 years. Duration is a measure of a bond portfolio's volatility, expressed as a number of years. A portfolio's duration might be lower than its average maturity because some of the securities it holds have variable interest rates. It is expressed as a number of years. A duration of 5.6 years means you can expect the portfolio's market value to decline by 5.6% if interest rates rise 1% after you buy your shares. And if rates decline by 1%, you can expect your market value to rise by 5.6%.
FLUD has an average duration of 0.6 years and an average effective maturity of 1.17 years. TUSI has an average duration of 0.7 years and an average effective maturity of 0.9 years.
"We expect positive returns for ultrashort even if rates continue to rise," Joanne Driscoll, Franklin Templeton's head of short-term liquid markets, told MarketWatch. "If rates fall, you can have better opportunities with core, but ultrashort will still have good returns."
Driscoll used the term "core" to refer to longer-term investment-grade bond portfolios.
Morningstar defines ultrashort bond funds as those that "invest primarily in high-quality U.S. bonds that mature within one year." Both Mayfield and Driscoll discussed how the ultrashort investing style gives them opportunities to buy longer-term bonds that are maturing in the near term. These may be sold at price discounts as managers of longer-term funds are forced to sell before maturity in order to keep their portfolios' durations above their own mandated levels.
When asked what she would say to investors worried about bond-market volatility, Driscoll said to "understand your time horizon" and added: "Really being consistent in how you allocate and taking a long-term view is important."
She co-manages several ETFs and mutual funds, including FLUD, the Putnam Ultra Short Duration Income Fund PSDTX and the Putnam Short Duration Bond Fund PARTX. PSDTX is managed in a similar manner to FLUD. PARTX quotes a 30-day yield of 3.78%, with an effective duration of 2.05 years as of Sept. 30. Its average maturity was 2.15 years as of Aug. 31. Over the past year, PARTX has returned 1.83%, as its share price has declined 2%.
"We bucket cash in three ways," Driscoll said. For "operating cash" that might be needed within six months, she believes investors should stick with money-market funds. For "strategic cash" that can sit for six to 12 months, she believes an ultrashort fund is ideal. For cash that can be committed for longer than 12 months, she believes it is appropriate to move up in maturity to a short-term bond fund, such as PARTX.
A volatility tip for investors
Mayfield cautioned investors to look not only at duration when considering a fund's volatility risk, but also at average maturity.
FLUD and TUSI are both in Morningstar's U.S. Fund Ultra Short Bond category, with FLUD rated three stars (out of five) and TUSI rated four stars.
The $32 billion Janus Henderson AAA CLO ETF JAAA has a four-star rating from Morningstar. It was moved from Morningstar's ultrashort category into the new U.S. Fund Securitized Bond-Focused category in April 2025. JAAA has a very low duration of 0.06 years, because it mainly holds floating-rate securities. But its weighted average maturity is 4.67 years.
JAAA's average maturity has increased as the fund has grown. It has been a good performer, but having an average maturity that is so much longer than its duration increases what investors call spread risk.
Even though we are now in a normal yield-curve environment, spreads between short- and long-term rates are narrow. This means a fund with a low duration but much higher average maturity will face price declines if and when interest-rate spreads widen. We have not been in an environment with a steep curve between short- and long-term rates since JAAA was launched in November 2020.
Currently, the rate on 3-month Treasury bills BX:TMUBMUSD03M is 1.22 percentage points below the yield on the 10-year Treasury note BX:TMUBMUSD10Y, compared with a spread of 0.93 percentage points a month ago.
So investors who want to take the strongest measures to limit price volatility in their bond funds need to look at average maturity, as well as duration.
More on the nuts and bolts of bond investing: Tax-free bond yields are in a sweet spot
-Philip van Doorn
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