In preparing for an eventual Federal Reserve rate hike and higher interest rates, fixed-income exchange traded fund investors can consider options that short bonds to hedge long debt positions.
There is a growing number of interest-rate-hedged bond ETFs for the shifting fixed-income environment ahead. For instance, the ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG) and the ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG) 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. Additionally, the Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY) provides another option to access high-yield, junk bonds, with a short 5-year Treasury bonds exposure to hedge against adverse movements in interest rates. [Building The Case for Hedging Interest Rate Risk: The Power of Zero Duration]
Recently, Deutsche Asset and Wealth Managment launched a group of rate-hedged bond ETFs, including the Deutsche X-trackers Investment Grade Bond – Interest Rate Hedged ETF (NYSEArca: IGIH), the Deutsche X-trackers High Yield Corporate Bond – Interest Rate Hedged ETF(NYSEArca: HYIH) and the Deutsche X-trackers Emerging Markets Bond – Interest Rate Hedged ETF (NYSEArca: EMIH). [Deutsche Bolsters Bond ETF Lineup With Three New Funds]
Additionally, for broad bond exposure, the WisdomTree Barclays U.S. Aggregate Bond Zero Duration Fund (NYSEArca: AGZD) and WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NYSEArca: AGND) help limit the effects of rising rates on a diverse group of fixed-income assets. [Long/Short Bond ETFs to Hedge Rate Risk, Generate Yields]
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. The short positions would essentially diminish the funds’ duration – a measure of sensitivity of the price of a fixed-income asset to changes in interest rate risks, so a a low duration would translate to a smaller sensitivity to shifting rates.
The ability to short bonds can act as a powerful hedge and return-enhancer when the credit market cracks, writes Dorothy C. Weaver, CEO of Collins Capital and former chairman of the Federal Reserve Bank of Atlanta, Miami branch, for MarketWatch.