With the threat or rising interest rates around the corner, yield investors can consider bond exchange traded funds that employ a type of long/short strategy to negate rate risk and still generate income.
For instance, investors can take a look at WisdomTree zero and negative duration bond ETFs, including 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). [Bond ETFs for Income Generation While Hedging Rate Risks]
AGZD has a -0.05 year effective duration and a 1.43% 30-day SEC yield. AGND has a -5.12 year duration and a 1.52% 30-day SEC yield. HYZD has a -0.16 year duration and a 5.0% 30-day SEC yield. Lastly, HYND has a -7.26 year duration and a 5.19% 30-day SEC yield.
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 – bond prices have an inverse relationship to interest rates, so rising rates corresponds with falling bond prices.
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.
ProShares also has similar strategies, including the ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG) and the ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG), which are comprised of long positions in USD-denominated corporate bonds issued by U.S. and foreign companies and take short positions in U.S. Treasury notes. IGHG has a -0.19 duration and a 3.53% 30-day SEC yield while HYHG has a -0.29 duration and a 6.34% 30-day SEC yield.
Additionally, the Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY) provides another option to access high-yield, junk bonds. Specifically, 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 shows a 0.29 year duration and a 5.15% 30-day SEC yield.
The long/short bond ETFs can provide an alternative means to invest in fixed-income assets and generate yields while diminishing the negative effects of rising rates on a bond fund’s price. Specifically, due to their near-zero durations, the bond funds should show little sensitivity to changes in interest rates.