Bond ETFs for Income Generation While Hedging Rate Risks

“While these strategies performed well during the Taper Tantrum, we would argue that investors might be disappointed when the limited income of such strategies could be tested when short rates start to rise,” Harper added.

Alternatively, investors can use fixed-income ETF strategies that mimic institutional hedging styles to manage risk.

For instance, the WisdomTree Barclays U.S. Aggregate Bond Zero Duration Fund (NYSEArca: AGZD), WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NYSEArca: AGND), WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NYSEArca: HYZD) and WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (NYSEArca: HYND) all try to diminish the risk of a rising rate environment without moving down to shorter durations by simply just hedging the interest rate risk instead.

Specifically, these new types of  zero duration or negative duration ETFs hold long-term bonds, but they will short Treasuries or Treasury futures contracts to hedge against potential losses if interest rates rise. Moreover, the negative duration ETFs try to profit off a rising rate environment by heavily using short contracts to capitalize on falling bond prices if rates do rise. However, due to the more aggressive nature of this strategy, these types of ETFs will underperform if rates fall.

Additionally, these hedged bond ETFs help preserve some income generation. AGZD has a 0.12 year effective duration and a 1.44% 30-day SEC yield. AGND has a -5.02 year duration and a 1.38% 30-day SEC yield. HYZD has a -0.34 year duration and a 4.23% 30-day SEC yield. Lastly, HYND has a -7.44 year duration and a 4.32% 30-day SEC yield.

Financial advisors who are interested in learning more about bond strategies for the changing fixed-income environment can listen to the webcast here on demand.