As Treasury yields spiked in response to the surprisingly weak U.S. economic data, interest-rate-hedged bond exchange traded funds are beginning to shine.
The yield on benchmark 10-year Treasury notes touched a high of 2.252% Wednesday, but retreated back to 2.19% Thursday, from the recent low of 1.845% in April 17.
U.S. Treasury yields rose to their highest level this year on Wednesday, with 30-year Treasury yields crossing over 3%, after a mix of poor data that suggested the economy may have shrunk over the first quarter and higher rates overseas pressured U.S. debt.
“It was something of a one-two punch between the trade-deficit report and higher interest rates that began overseas,” Alan Gayle, senior investment strategist and director of asset allocation at RidgeWorth Investments, said in a Reuters article.
Consequently, the rising rates dragged on fixed-income assets – bond prices and yields have an inverse relationship. For instance, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) dipped 0.3% over the past week and was up 0.1% over the past month, and the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYESArca: LQD) declined 1.4% over the past week and fell 2.9% over the past month. [Alternative Bond ETFs for a Rising Rate Environment]
In contrast, zero-duration or interest-rate-hedged ETFs that try to negate the negative effects of higher rates have done their job and outperformed the non-hedged HYG and LQD as interest rates rose.
For instance, investors may find hedged high-yield options, including the WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NYSEArca: HYZD), ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG) and Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY), he iShares Interest Rate Hedged High Yield Bond ETF (NYSEArca: HYGH) and recently launched Deutsche X-trackers High Yield Corporate Bond – Interest Rate Hedged ETF(NYSEArca: HYIH). [Fixed-Income ETFs That Beat Interest Rate Risk]
HYZD was down 0.7% over the past week but gained 0.7% over the past month. HYHG rose 0.1% over the past week and 1.9% over the past month. THHY returned 0.3% over the past week and 1.2% over the past month. HYGH increased 0.3% over the past week and 0.6% over the past month. HYIH advanced 1.9% over the past week and 2.1% over the past month.
Additionally, while slightly underperforming their junk bond counterparts, the hedged investment-grade bond ETFs still outpaced the non-hedged investment-grade corporate bond options. For instance, the actively iShares Interest Rate Hedged Corporate Bond ETF (NYSEArca: LQDH) down 0.3% over the past week and up 0.2% over the past month. The recently launched Deutsche X-trackers Investment Grade Bond – Interest Rate Hedged ETF (NYSEArca: IGIH) fell 0.7% over the past week and 0.2% over the past month. Lastly, the ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG) added 0.2% over the past week and 0.4% over the past month.
These new types of zero duration or negative duration ETFs hold long-term bonds, but they will take short positions in Treasuries or Treasury futures contracts to hedge against potential losses if interest rates rise. 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. Moreover, as yields have been inching higher and Treasury bond prices fell over recent weeks, the short Treasury positions helped bolster returns in the rate-hedged bond ETFs.
However, potential investors should be aware that since these bonds hold short Treasury positions, these rate-hedged ETFs may underperform non-hedged bond ETFs if Treasury yields fall and Treasuries begin to rebound.
For more information on the fixed-income market, visit our bond ETFs category.