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.