One hot area in the ETF market is bond products that provide decent yields while also providing some cushion against the negative impact of rising interest rates.
For example, bank loan ETFs such as PowerShares Senior Loan Portfolio (NYSEArca: BKLN) have seen hefty inflows this year. They pay above-average yields and have a built-in buffer against higher rates since the ETFs track floating-rate securities. [Bank Loan ETF Inflows Continue to Amaze]
“Several strategists have spoken about rotating out of high-yield corporate bond ETFs and into bank loan ETFs at these price levels, so we may be seeing these words put into action by institutional managers,” said Paul Weisbruch, head of ETF/options sales and trading at Street One Financial.
Also, some investors are using high-yield ETFs with shorter durations to maintain exposure to the asset class while reducing rate risk. These funds include PIMCO 0-5 Year High Yield Corporate Bond Index (NYSEArca: HYS) and SPDR Barclays Short Term High Yield Bond ETF (NYSEArca: SJNK). [High-Yield Bond ETFs that Protect Against Rising Interest Rates]
Now, ETF provider ProShares is going a step further with a new high-yield bond ETF that seeks to all but eliminate the risk of rising rates.
The Bethesda, Md.-based firm on Thursday launched ProShares High Yield-Interest Rate Hedged (BATS: HYHG). The ETF uses Treasury futures to provide a built-in hedge against rising interest rates.
HYHG maintains short positions in 2-, 5- and 10-year U.S. Treasury futures contracts to hedge its portfolio against possible rate increases.
The new ProShares ETF looks like it will be competing with Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY) and First Trust High Yield Long/Short ETF (NasdaqGM: HYLS). [Hedged Junk Bond ETF]
Next page: ‘Hunt for income’
“We believe that many investors in high yield bond funds may be focused on credit risk but overlook the risk presented by rising rates. When rates go up, they could be in for an unpleasant surprise,” said Michael Sapir, Chairman and CEO of ProShare Advisors.
Steve Cohen, managing director at ProShares, in a telephone interview Thursday said the firm wanted to launch a high-yield product that wasn’t “plain-vanilla.” The company is best known for its alternative ETFs, including leveraged and inverse funds.
“There is definitely a hunt for income,” Cohen said. “There have been strong flows to high-yield bonds the past few years. What’s missing here is an ETF that can hedge out interest rate risk when rates go up.”
The short-duration junk bond ETFs such as HYS and SJNK do have some rate risk. For example, HYS has an effective duration of nearly 2 years, while SJNK has a modified adjusted duration of roughly 4 years.
Cohen said the new ProShares ETF attempts to match the durations of the high-yield bond holdings with short positions in Treasury futures across the curve. This seeks to substantially eliminate duration and interest-rate risk, he added.