Rates hit a 15-year high. Here are 3 ETFs for what’s next

Five years ago, the frustration with bonds was how little income they offered. Today, the yields look far more appealing, but investors face a different worry: buying now and watching prices fall if yields rise again.

The RBA's latest move has brought that concern back into focus. On 29 September, the central bank raised the cash rate to 4.60%, its fourth increase this year. Inflation has proved stubborn: at 4.0% in August¹, it remains well above the RBA's 2–3% target band, and further rate rises remain a possibility.

Public spending isn't making the RBA's job any easier. Federal payments are budgeted at 26.8% of GDP in 2026–27, against 24.5% in 2018–19, keeping a high floor under demand just as the RBA is trying to cool it.² Higher energy costs add to the pressure on prices.

Yet that difficult backdrop has also created an opportunity. Ten-year Australian government bond yields touched 5.40% in early October, levels last seen in 2011³. Higher yields mean more income, and that income can act as a buffer when bond prices fall.

Chart 1 shows how much bigger that buffer is today. It compares Australian Treasury bonds in September 2021, when yields were below 1%, with September 2026, when they were above 5%⁴.

What happens if you're early?

Bloomberg AusBond Treasury 0+ Yr Index | benchmark-proxy illustration

Source: BlackRock - 30 Sep 2021. 30 Sep 2021: yield 0.99%, duration 6.48 years | 30 Sep 2026: yield 5.11%, duration 5.14 years⁵

If yields rose by another percentage point, our estimate suggests a year of income at September 2026 levels would cover almost the entire price fall, leaving a result of −0.03% before fees⁶. At September 2021 levels, the same rise would have meant a loss of 5.49%⁷.

Most of that difference comes from income, helped by slightly lower sensitivity to rate changes. Prices would still fall, but today's income provides a much bigger buffer against them.⁸

A bigger income cushion helps, but it doesn't tell investors what happens next. Rather than build the whole portfolio around one forecast, three ETF strategies can each do a different job in the portfolio - offering short-term income, adding credit income and providing inflation-linked exposure.

Each strategy has a different role as rates and inflation change.

For the part of a portfolio that needs to stay flexible, the iShares Enhanced Cash ETF (ISEC) offers a yield to maturity of 4.94% with interest rate duration of 0.18 years⁹. That leaves relatively little sensitivity to further yield rises, although investors should be aware that the compromise comes when rates fall - income can decline as the portfolio reinvests.

Holding part of the portfolio in ISEC can also keep options open. Rather than locking in a view on rates now, investors can move into longer bonds or credit if better opportunities arise.

For income beyond cash, the iShares Credit Income Active ETF (ICME) offers diversified exposure to Australian credit - a market now paying more income as yields have risen. Its yield to maturity of 7.16%¹⁰ is about 2.6 percentage points above the RBA cash rate target¹¹, while interest rate duration of just 0.62 years¹² keeps rate sensitivity low.

The fund searches for value across sectors and up and down the capital stack. Around 80% currently sits in subordinated debt¹³, but it can move towards senior bonds, hybrids or securitised assets as conditions change.

Income matters less if inflation erodes what it can buy. The iShares Government Inflation ETF (ILB) invests in government and semi-government bonds whose value is adjusted for inflation, helping a portfolio keep pace with rising prices.

ILB’s real yield of 2.59%¹⁴ is what the underlying bonds offer above inflation. The trade-off is interest rate duration of 6.64 years¹⁵, so ILB's price can fall if real yields rise, even while inflation remains high.

Each of these funds could respond differently depending on what happens next. Inflation could keep rates high, while unemployment's rise over the past year to 4.6%¹⁶ points to a gradually cooling labour market.

The five scenarios below show which strategy could potentially perform well in each environment.¹⁷

Taken together, these exposures spread the sources of risk rather than relying on one rate forecast.

Bond investors face two main risks. Interest rate risk is the chance that bond prices fall because interest rates rise. Spread risk is the chance that company bond prices fall because investors demand more income for lending to companies rather than the government – something that tends to happen when worries about the economy or defaults grow.

Duration is a simple guide to how sensitive a fund is to each risk: the higher the number, the bigger the likely price move.

Each fund leans on a different risk. ISEC carries little of either, ICME mostly carries spread risk, and ILB mostly carries interest rate risk (in its case, to real yields – the part of the yield above inflation). Below is an example of what it looks like if you combine these three ETFs into an equal-weighted portfolio.

Chart 2. Interest rate and spread duration, with an equal-weighted blend. Source: BlackRock Aladdin, 30 September 2026. ILB's interest rate sensitivity is to real yields. Duration is not a measure of total risk. Duration is an estimate based on current portfolio holdings and is subject to change. Not a guarantee of future distributions or investment performance.

Held together, the three funds give a portfolio more than one way to be paid. ISEC keeps part of it liquid, ICME adds credit income and ILB helps protect purchasing power. In each of the five scenarios above, at least one is positioned to do well, so the outcome doesn't hinge on a single rate call.

When the path for rates is this uncertain, diversifying across different sources of return can help investors take advantage of a range of outcomes.¹⁹