Ten-year Treasury yields jumped nearly 130 basis points last year and with those yields expected to climb higher in 2014, investors are searching for exchange traded funds with which to successfully fight rising rates.
Among bond ETFs, bank loan and ultra-short duration products have been favored stomping grounds for investors looking to cope with rising rates. In a sign of the times, investors poured $36 billion into short-duration ETFs last year. [Short Duration ETF Showdown]
Another option to consider is hedged high yield bonds, which can be accessed with the Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY).
“A handful of factors may make the hedged high yield approach worthy of closer consideration if 2014 is going to be a year of rising interest rates,” said Market Vectors fixed income portfolio manager Fran Rodilosso in a statement.
Factors highlighted by Rodilosso include narrowing credit spreads and long high yield/short Treasury positioning. That strategy has historically been more responsive to changes in credit spreads than the floating rate mechanism employed by bank loans, according to Market Vectors. [High-Yield ETFs With Built in Interest Rate Hedges]
Rodilosso went on to note that when credit spreads widen significantly and interest rates fall, hedged high yield bond strategies present a risk of loss and tend to underperform bank loans.
THHY tracks the Market Vectors U.S. Treasury-Hedged High Yield Bond Index, which tracks U.S. denominated speculative grade debt and takes short positions in 5-year Treasury notes. Specifically, the fund offsets its long position with a 97.4% short position in U.S. Treasuries. The ETF debuted in March 2013.
One way of looking at THHY is that the ETF offers compensation for the investor that believes interest rates will rise but does not know exactly when that will happen. THHY has a 30-day SEC yield of 4.16% and a yield to worst of 4.48%. Over 81% of the fund’s 64 holdings are rated BB or B, according to issuer data.
“For investors who value liquidity and who believe rising interest rates are on the way, the hedged high yield bond approach may be worth a closer look,” said Rodilosso.
Market Vectors Treasury-Hedged High Yield Bond ETF
ETF Trends editorial team contributed to this post.