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Bond Funds Face Risks

Bond ETFs like the iShares Barclays 1-3 Year Treasury Bond could be in bubble territory.

NEW YORK (TheStreet) -- Treasury bond exchange-traded funds like iShares Barclays 1-3 Year Treasury Bond (SHY) - Get iShares 1-3 Year Treasury Bond ETF Report, iShares Barclays Short Treasury Bond (SHV) - Get iShares Short Treasury Bond ETF Report and iShares S&P/Citi 1-3 Yr International Treasury Bond (ISHG) - Get iShares 1-3 Year International Treasury Bond ETF Report could be in bubble territory, and investors need to be aware of the concomitant risks.

Prices of Treasuries have risen, and their yields have fallen, as investors have shunned stocks and turned to fixed-income investments because of concerns about the overall health of the global economy and fears of a double-dip recession.

The Investment Company Institute reports that from January 2008 through June 2010, outflows from equity funds totaled $232 billion while bond funds have seen a massive $559 billion of inflows. This trend has pushed long-term bond prices up and yields down. In fact, on an inflation-adjusted basis, there is a negative yield for most short-term bonds.

Bonds could suffer, however, from rising interest rates in coming years. Granted, economic slack, low inflation levels and stable inflation expectations likely will enable the

Federal Reserve

to maintain its target rate at record low levels through 2010 and even into 2011. But the Fed will eventually have to tighten rates, and this will make bonds less attractive.

Lastly, inflation could eventually crimp the bond markets. Because of the mammoth federal deficit, the Federal Reserve will likely have no other choice than to print dollars and increase money supply. If and when this happens, increases in inflation -- as reflected by the consumer price index -- will eat away at the yields and real returns of bonds.

As mentioned before, some bond ETFs that could be influenced by these trends include:

iShares Barclays 1-3 Year Treasury Bond, which has a yield of 1.23% and closed at $84.29 on Monday.

iShares Barclays Short Treasury Bond, which has a yield of 0.14% and closed at $110.21 on Monday.

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iShares S&P/Citi 1-3 Yr International Treasury Bond, which has a yield of 1.04% and closed at $99.61 on Monday.

To mitigate the risks involved in the aforementioned bond ETFs, it's important to use an exit strategy that identifies price points at which a positive trend may come to an end. Such an exit strategy can be found at


-- Written by Kevin Grewal in Houston.

At the time of publication, Grewal had no positions in equities mentioned.

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Kevin Grewal is the founder, editor and publisher of

ETF Tutor and serves as the editor at , where he focuses on mitigating risk and implementing exit strategies to preserve equity. Additionally, he is the editor at The ETF Institute, which is the only independent organization providing financial professionals with certification, education, and training pertaining to exchange-traded funds (ETFs). Prior to this, Grewal was a quantitative analyst at a small hedge fund where he constructed portfolios dealing with stock lending, exchange-traded funds, arbitrage mechanisms and alternative investments. He is an expert at dealing with ETFs and holds a bachelor's degree from the University of California along with a MBA from the California State University, Fullerton.