When viewed as a complement to an unhedged portfolio, each 20% allocation to the negative duration strategy could generate a reduction of over two years of duration, but sacrifice 40 bps in yield relative to the Agg. A 48% allocation to the negative duration strategy could bring the duration of the overall portfolio to zero and retain a net yield of 1.05% (48% of the Agg’s yield). While this portfolio has a similar duration profile to the zero duration strategy, the yield is marginally higher in order to compensate investors for the potential hedge mismatch and shifts in the yield curve.
In our view, zero and negative duration strategies offer investors a more intuitive way to manage interest rate risk in their portfolio relative to traditional approaches. Given that we may be heading into a particularly uncertain period in markets, we believe that investors should consider reducing interest rate risk in advance of any change in Fed policy. In our view, interest-rate-hedged strategies allow investors to maintain exposure to fixed income sectors they currently hold while reducing the risk of rising interest rates.
1These are: Barclays Rate Hedged U.S. Aggregate Bond Index, Zero Duration and BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained, Zero Duration Index.
2These are: Barclays Rate Hedged U.S. Aggregate Bond Index, Negative Five Duration and BofA Merrill Lynch 0-5 Year U.S. High Yield Constrained, Negative Seven Duration Index.
3As proxied by the Barclays U.S. Aggregate Index.
4Source: Barclays, as of 3/13/15.
5Source: Barclays, as of 2/28/15.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. The Fund seeks to mitigate interest rate risk by taking short positions in U.S. Treasuries, but there is no guarantee this will be achieved. Derivative investments can be volatile, and these investments may be less liquid than other securities and more sensitive to the effects of varied economic conditions.
Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline. The Fund may engage in “short sale” transactions of U.S. Treasuries, where losses may be exaggerated, potentially losing more money than the actual cost of the investment, and the third party to the short sale may fail to honor its contract terms, causing a loss to the Fund. While the Fund attempts to limit credit and counterparty exposure, the value of an investment in the Fund may change quickly and without warning in response to issuer or counterparty defaults and changes in the credit ratings of the Fund’s portfolio investments. Investing in mortgage- and asset-backed securities involves interest rate, credit, valuation, extension and liquidity risks and the risk that payments on the underlying assets are delayed, prepaid, subordinated or defaulted on. Due to the investment strategy of certain Fund’s they may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.