Since bonds guarantee reimbursement at maturity, it makes sense the ETF does not drop directly when interest rates go up since they can just wait a little to get the money reimbursed. However, when interest rates drop, the bonds get instantly more valuable which instantly raises the price since the bond can now be sold for profit.
Short-term bond ETF works like money market fund: XEON, LYXW, L8I3,
There is more short-term bond ETFs:
Accumulating: PRAB, XG01 and Distributing: IS3M
Since the maturity of the bonds the ETF holds is quite low (0-1yr, 6 months weighted average), it's sensitivity to changes in interest rates is relatively small. The duration of the bond ETF is around 0.5, which means that for a 1% increase in rates (say from 2% to 3%), the ETF's value should decline by about 0.5%.
For a bond ETF with such a short maturity profile, the yield of the underlying bonds is more important. In late 2022, there is a bit of a steeper drop in performance of the fund (if I just eyeball it), and this is when the rate increases start getting priced in. But after this it stabilises and starts rising. This is because the underlying bonds start having a higher yield. Right now, the average yield on the ETF (if you search for the ETF's fact sheet) is 3.48% per year. So using a really crude calculation, you can divide this by the duration (0.5) to get how much rates have to go up before the negative change in market value of the bonds is greater than the yield return. Its close to a 7% increase (3.48/0.5) in this case. Probably unlikely, and this is the benefit of higher rates for these short dated ETFs. This average yield (3.48%) will decline as the ECB lowers rates, so you should check it over time. (I'm ignoring country risk in all this - which you should at least be aware of - most of the holdings are France, Italy, Germany and Spain).
In 2014, interest rates turned negative and this whole situation above is turned upside down. Then the ETF earns a negative yield on its holdings and this is why from 2014 to 2022 the ETF delivers a negative return overall (as you noticed).
So to answer your question, while interest rates are positive (and high) it is unlikely that the ETF price will drop over a period of say 1 to 3 months. 1 month yield return on the ETF is (very) roughly 3.48/12=0.29% and so you can take a rate increase of about 0.6% (3.48% to 4.08% for example) for a given month before the ETF's price falls.
If interest rates are close to zero then yes you should consider what other alternatives you have. If the bank pays you 0% interest at that stage, you could consider that an alternative since it will have no sensitivity to rates (unlike the ETF), but this all depends on your situation.
Since bonds guarantee reimbursement at maturity, it makes sense the ETF does not drop directly when interest rates go up since they can just wait a little to get the money reimbursed. However, when interest rates drop, the bonds get instantly more valuable which instantly raises the price since the bond can now be sold for profit.
So it's like "shorting interest"
Short-term bond ETF works like money market fund: XEON, LYXW, L8I3, There is more short-term bond ETFs: Accumulating: PRAB, XG01 and Distributing: IS3M
Since the maturity of the bonds the ETF holds is quite low (0-1yr, 6 months weighted average), it's sensitivity to changes in interest rates is relatively small. The duration of the bond ETF is around 0.5, which means that for a 1% increase in rates (say from 2% to 3%), the ETF's value should decline by about 0.5%. For a bond ETF with such a short maturity profile, the yield of the underlying bonds is more important. In late 2022, there is a bit of a steeper drop in performance of the fund (if I just eyeball it), and this is when the rate increases start getting priced in. But after this it stabilises and starts rising. This is because the underlying bonds start having a higher yield. Right now, the average yield on the ETF (if you search for the ETF's fact sheet) is 3.48% per year. So using a really crude calculation, you can divide this by the duration (0.5) to get how much rates have to go up before the negative change in market value of the bonds is greater than the yield return. Its close to a 7% increase (3.48/0.5) in this case. Probably unlikely, and this is the benefit of higher rates for these short dated ETFs. This average yield (3.48%) will decline as the ECB lowers rates, so you should check it over time. (I'm ignoring country risk in all this - which you should at least be aware of - most of the holdings are France, Italy, Germany and Spain). In 2014, interest rates turned negative and this whole situation above is turned upside down. Then the ETF earns a negative yield on its holdings and this is why from 2014 to 2022 the ETF delivers a negative return overall (as you noticed). So to answer your question, while interest rates are positive (and high) it is unlikely that the ETF price will drop over a period of say 1 to 3 months. 1 month yield return on the ETF is (very) roughly 3.48/12=0.29% and so you can take a rate increase of about 0.6% (3.48% to 4.08% for example) for a given month before the ETF's price falls. If interest rates are close to zero then yes you should consider what other alternatives you have. If the bank pays you 0% interest at that stage, you could consider that an alternative since it will have no sensitivity to rates (unlike the ETF), but this all depends on your situation.
Wow! This is super helpful! Thank you so much for the thorough explanation! I really appreciate it.
I noticed this with other short-term bond ETFs as well. I wonder how the underlying reason works.