High-yield, “junk” bonds investors could be in for a rude awakening when interest rates tick higher. To combat interest rate risk, Van Eck Global, the money manager behind the Market Vectors exchange traded funds, recently launched a hedged junk bond fund.
The Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY) began trading Friday. The ETF tries to reflect the performance of the Market Vectors U.S. Treasury-Hedged High Yield Bond Index, which holds below investment grade corporate bonds denominated in U.S. dollars that are hedged against rising interest rates through exposure to Treasury notes. THHY has a 1.45% expense ratio.
Specifically, the fund’s underlying index employs a type of long/short strategy where it will go long junk bonds and short 5-year Treasury bonds to hedge against adverse movements in interest rates. Interest rates and bond prices have an inverse relationship – rising rates translates to lower bond prices.
“This is high yield while you wait,” Ed Lopez, Marketing Director at Van Eck Global, said in an email. “If you are of the opinion that interest rates are going rise, but you just don’t know when, this ETF offers, in a single fund, the potential to cover the costs of hedging interest rate risk with income earned from high yield bonds.”
Potential investors should be aware that the strategy presents significant risk of losses in a “risk-off” environment since U.S. Treasuries would rally and high-yield debt would likely underperform.
Dividends are expected to be distributed monthly.
THHY’s tracking index has 670 holdings, but not all are held by the fund. The index’s credit quality includes BBB 0.2%, BB 38.6%, B 45.2%, CCC 13.2% and CC 1.0%, with a short position of -100% in U.S. sovereign debt.
The index’s sector breakdown includes communications 21.2%, consumer non-cyclical 17.3%, energy 15.8%, consumer cyclical 12.8%, industrial 6.6%, technology 4.6%, basic materials 3.6%, diversified 0.1%, financials 13.1% and utilities 4.7%.
The current environment favors high-yield debt because slow economic growth has historically supported high-yield bonds, a healthy corporate credit environment and loan defaults are at historical lows.
The Market Vectors ETF will be competing against the recently launched First Trust High Yield Long/Short ETF (NasdaqGM: HYLS), an actively managed ETF that holds U.S. and non-U.S. corporate debt, bank loans and convertible bonds, with both long and short positions. Additionally, the fund can take short positions in U.S. Treasuries or investment grade corporate debt. [First Trust Launches Active High-Yield ETF]
Additionally, the ProShares High Yield Interest Rate Hedged ETF is waiting on regulatory approval.
For more information on new product launches, visit our new ETFs category.
Max Chen contributed to this article.
Story updated to correct the holdings of THHY.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.