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.
Moreover, Blair Ridley, director and portfolio manager for municipal bonds at Deutsche Asset & Wealth Management, argues that with higher tax rates, tax-exempt municipal bonds are more valuable and offer attractive diversification benefits.
For example, investors can take a look at the Deutsche X-Trackers Municipal Infrastructure Revenue Bond Fund (NYSEArca: RVNU), which seeks to reduce exposure to public pension risk, not avoid or eliminate it, by focusing solely on bonds that fund, state and local infrastructure projects such as water and sewer systems, public power systems, toll roads, bridges, tunnels, and many other public use projects. The interest and principal repayments are generated from dedicated revenue sources as opposed to general obligation bonds that have come under greater scrutiny. [The Right Municipal Bond ETF Right Now]
Additionally, ETF investors have many more income-generating options to choose from. According to a press release, DeAWM launched four new high-dividend-yield, currency-hedged ETFs Wednesday, including the Deutsche X-trackers MSCI EAFE High Dividend Yield Hedged Equity ETF (NYSEArca: HDEF), Deutsche X-trackers MSCI Eurozone High Dividend Yield Hedged Equity ETF (NYSEArca: HDEZ), Deutsche X-trackers MSCI Emerging Markets High Dividend Yield Hedged Equity ETF (NYSEArca: HDEE) and Deutsche X-trackers MSCI All World ex-US High Dividend Yield Hedged Equity ETF (NYSEArca: HDAW). [Currency Hedged ETFs Power Deutsche AWM’s ETF Ascent]
The international dividend ETFs provide attractive yields than most liquid asset classes – the high-dividend-yield indices select companies with dividend yields greater than or equal to 1.3 times the yield of the parent index. Additionally, the new funds also utilize forward currency contracts to diminish the negative effects of an appreciating U.S. dollar or weakening foreign currencies.
Deutsche Asset & Wealth Management’s push into alternative, smart-beta index-based ETFs has been very popularly received by investors, with the provider’s X-trackers platform holding $20 billion in assets under management as of August 7.
Financial advisors who are interested in learning more about ETF income strategies can listen to the webcast here on demand.