In anticipation of the Federal Reserve’s changes to its loose monetary policy, investors can take a look at alternative exchange traded fund income strategies that help mitigate potential risks down the road.
On the recent webcast, ETF Income Strategies for Today’s Intelligent Advisor, Bill Chepolis, managing director and co-head of fixed income for North America at Deutsche Asset & Wealth Management, warned that compensation for duration risk has been the lowest on record after a multi-year bull run in the fixed-income market in response to the loose Fed policies. Consequently, fixed-income investors are now exposed to greater risks, without enough compensation for their risk exposure.
“Federal Reserve’s low interest rate policy has led to historically high rate volatility, which is likely to persist for some time to come,” Chepolis said.
Alternatively, with yields ticking higher, bond investors can utilize rate-hedged bond ETFs to generate income and help better maintain their principle. In March, DeAWM introduced 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 Adds Three New Bond ETFs]
IGIH tracks investment-grade corporate bonds, HYIH includes a group of speculative-grade junk bonds and EMIH follows U.S.-dollar-denominated emerging market bonds. However, unlike traditional bond ETFs, these options try to mitigate interest rate sensitivity across the yield curve in a rising rate environment by taking short positions in U.S. Treasury futures.
Through their short positions, IGIH, HYIH, and EMIH have a modified duration of about zero years -duration is a measure of a bond fund’s sensitivity to changes in interest rates. Consequently, since these bond ETFs essentially have a zero duration, a rising interest rate would not negatively affect the investments.