Fixed income exchange traded funds, particularly those with exposure to the longer end of the yield curve, have been the place to be this year.
The S&P 500 has looked pitiful in comparison to ETFs such as the PIMCO 25+ Year Zero Coupon U.S. Treasury Index Fund (NYSEArca: ZROZ) and the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT), which have posted year-to-date gains of 34.8% and 19.2%, respectively.
This year’s action in Treasury yields would appear to indicate that the Federal Reserve will not be raising interest rates anytime soon. Of course, there are market observers that believe the opposite is true, particularly if the U.S. economy continues expanding.
On that note, one of the most prominent themes in the ETF industry dating back to last year has been investors’ increased interest in low duration bond funds as a means of protecting portfolios against what many believe is an inevitable rise in interest rates.
Issuers have met that increased interest with a growing number of bond ETFs that target exceptionally low, and in some cases, negative duration as wells funds that offer interest rate hedges.
In this list, we explore an array of hedged and negative duration ETFs. After all, while a Fed rate hike may not be imminent, it pays to be prepared. Let’s get started with the…
Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY)
30-Day SEC Yield: 4.96%
Effective Duration: 0.23 years
Comment: THHY provides another option to access high-yield, junk bonds. 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.
THHY holds short positions in U.S. Treasuries, which has weighed on the ETF’s performance this year, but the reverse should be true if rates rise. The ETF has 91 holdings, nearly half of which are rated BB.
WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NasdaqGM: HYZD)
30-Day SEC Yield:
Effective Duration: -0.23 years
Comment: Negative and zero duration ETFs give investors another avenue for maintaining fixed income exposure even as interest rates rise without the vulnerability of Treasuries and, in the case of HYZD, without having to make a significant sacrifice in terms of yield.
Like THHY, HYZD is short Treasuries, a tough game to play in 2014. “In the case of zero duration strategies strategies, investors were primarily rewarded by assuming credit and prepayment risk but did not necessarily benefit from falling U.S. interest rates. Since these strategies seek to reduce or modify exposure to movements in nominal U.S. interest rates, it should stand to reason that returns will generally be lower than long-only strategies as rates fall,” said WisdomTree in a note out earlier this week. [WisdomTree: Rising Rate Strategy Performance in a Falling Rate Environment]
WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (NYSEArca: HYND)
30-Day SEC Yield: 4.59%
Effective Duration: -7.55 years
Comment: HYND takes short Treasury positions to the extreme, pushing down the portfolio’s effective duration even further. With its significant negative duration, HYND will pursue an outperformance strategy in a rising rate environment, instead of just simply hedging against rate risk. However, potential investors should be aware that a drop in interest rates will weigh on this ETF.
ProShares High Yield-Interest Rate Hedged ETF (BATS: HYHG)
30-Day SEC Yield: 5.42%
Effective Duration -0.37 years
Comment: HYHG tries to reflect the performance of the Citi High Yield (Treasury Rate-Hedged) Index, which tracks a basket of high-yield bonds with a built-in hedge against rising interest rates. The fund tracks bond securities issued from the U.S. or Canada with at least one year remaining to maturity
Investors like the idea. It took HYHG just over a year to acquire almost $152 million in assets under management, according to issuer data.
he iShares Interest Rate Hedged High Yield Bond ETF (NYSEArca: HYGH).
30-Day SEC Yield: 5.87%
Effective Duration: 0.37 years
Comment: The actively managed iShares rate-hedged high-yield bond ETF also takes on short positions in U.S. Treasury futures to mitigate interest rate risk of a portfolio of U.S. dollar-denominated, high-yield corporate bonds. As rates rise, Treasury bond prices fall, so a short position capitalizes on the falling bond prices.
iShares Interest Rate Hedged Corporate Bond ETF (NYSEArca: LQDH)
30-Day SEC Yield: 3.39%
Effective Duration: -0.01 years
Comment: With its May debut, LQDH is the newest ETF on this list. LQDH holds a position in the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYESArca: LQD) and shorts Treasuries in an effort to mute interest rate risk. Six of LQDH’s top-10 holdings are issued by members of the Dow Jones Industrial Average, including Verizon (NYSE: VZ), Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE).
ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG)
30-Day SEC Yield: 3.53%
Effective Duration: -0.26%
Comment: Like its high-yield counterpart, IGHG takes on short positions in Treasury securities to mitigate rate risk, along with long positions in U.S.- and internationally domiciled company debt with a minimum rating of BBB-, or low investment-grade.
First Trust Tactical High Yield ETF (NasdaqGM: HYLS)
30-Day SEC Yield: 5.92%
Net Weighted Average Duration: 3.14 years
Comment: HYLS is an actively managed ETF that tries to provide current income through a diversified portfolio of high-yield debt securities rated below investment grade or unrated while capital appreciation is a secondary objective.
HYLS can hold 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. [10 Unique ETF Sources of Yield]
Editorial team contributed to this article.