Fixed-income investors who still rely on cash generation but are wary about the rising rates can turn to rate-hedged bond exchange traded funds to diminish rate risks.
Yields on benchmark 10-year Treasuries briefly touched 2.44% mid-day Friday, its highest intraday level since October, after a report revealed improved May jobs numbers.
“If growth continues to improve and wage inflation ticks higher,” bond yields have room to rise, Christopher Sullivan, chief investment officer at the United Nations Federal Credit Union, said in a Wall Street Journal article.
With yields ticking higher, bond investors can utilize rate-hedged bond ETFs to generate income and help better maintain their principle.
For instance, the ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG) and Deutsche X-trackers High Yield Corporate Bond – Interest Rate Hedged ETF(NYSEArca: HYIH) both track high-yield, speculative-grade bonds but hedge their positions by shorting Treasury bonds to create portfolios with near zero duration – duration is a measure of a bond fund’s sensitivity to changes in interest rates, so a zero duration effectively reflects the funds’ shows a bonds unresponsiveness to rising interest rates.
Over the past month, yields on 10-year Treasuries have increased about 20 basis points. Meanwhile, the non-hedged iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) dipped 0.7% in the past month while HYHG was flat and HYIH gained 0.7%.
Additionally, for investment-grade corporate bond exposure, investors can take a look hedged options like the Deutsche X-trackers Investment Grade Bond – Interest Rate Hedged ETF (NYSEArca: IGIH) and ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG).
Over the past month, the non-hedged iShares iBoxx $ Investment Grade Corporate Bond ETF (NYESArca: LQD) declined 1.5%, whereas IGIH dipped 0.5% and IGHG was 0.6% lower.
Nevertheless, potential investors should be aware that these types of zero-duration, hedged bond ETFs may underperform a non-hedged version if rates decline.
Looking further out, these types of hedged-bond ETFs could provide suitable exposure to the fixed-income market in a rising interest environment, especially as the Federal Reserve plans on hiking rates sometime later this year.
“The odds of a rate increase in September are increasing,’’ Mike Lorizio, senior fixed income trader at Manulife Asset Management, said in the WSJ article.
For more information on the fixed-income market, visit our bond ETFs category.
Max Chen contributed to this article.