The prospect of rising interest rates in 2013 drove the introduction of interest rate-hedged high-yield bond exchange-traded funds (ETFs). These products are designed specifically to help limit interest rate sensitivity (or duration1) by shorting U.S. Treasuries.
2013 was also the biggest year for bank loan issuance since 2007, and bank loan ETF inflows were massive. Both hedged high-yield bonds and bank loans help reduce interest rate sensitivity, isolating credit risk of below investment-grade issuers. Although hedged high-yield investors use some yield to pay for the interest-rate hedge, they still are exposed to high-yield bonds, which outperformed bank loans in 20132:
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Source: FactSet. Data as of February 21, 2014 since MVTHHY Index’s February 5, 2013 inception. Index performance is not illustrative of fund performance. Fund performance current to the most recent month end is available by visiting marketvectorsetfs.com. Historical performance is not indicative of future results; current data may differ from data quoted. Indexes are unmanaged and are not securities in which an investment can be made.
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While bank loans are senior and secured, high-yield bonds tend to have better call protection and trade more actively in the secondary market. Bonds also settle on a T+3 basis versus an average of two to four weeks for loan assignments to take place. High-yield ETFs have held significant assets through various market cycles, including periods of heavy outflows; bank loan ETFs are yet to be tested for liquidity on a similar scale.
A Treasury-hedged high-yield approach may offer investors the opportunity to isolate credit risk and the return and income potential of high yield bonds, while at the same time reducing interest rate risk.
Fran Rodilosso is co-portfolio manager of the Market Vectors Treasury-Hedged High Yield Bond ETF (NYSE Arca: THHY). Launched in March 2013, it was the first U.S. passively managed ETF of its kind.
1Duration measures a bond’s sensitivity to interest rate changes that reflects the change in a bond’s price given a change in yield.
2Hedged-high-yield bonds are represented by the Market Vectors US Treasury-Hedged High Yield Bond Index, which outperformed bank loan strategies, as represented by the S&P/LSTA U.S. Leveraged Loan 100 Index, since the former’s inception date of February 5, 2013. Current fund information can be found at marketvectorsetfs.com.
Please note that the information herein represents the opinion of the portfolio manager and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. ©2014 Van Eck Global