For example, the popular investment-grade corporate bond ETF, iShares iBoxx $ Investment Grade Corporate Bond ETF (NYESArca: LQD), has a 8.31 year effective duration and a 3.19% 30-day SEC yield, so a 1% increase in interest rates could translate to a 8.31% decline in the ETF’s price.
Alternatively, something like the iShares Interest Rate Hedged Corporate Bond ETF (NYSEArca: LQDH) holds short positions in interest rate swaps, which provides the rate-hedged ETF with a 0.03 effective duration – a 1% rise in interest rates would translate to a 0.03% decline in the funds price, and LQDH would still offer up a 3.43% 30-day SEC yield.
The near zero-duration target should help an interest-rate-hedged ETF outperform its non-hedged options if rates continue to rise. For instance, since the yield on benchmark 10-year Treasury bonds rose to its current level of around 1.86% from the 1.57% low on February 11, the non-hedged LQD gained 4.2% while the hedged LQDH rose 5.7%. Similarly, the Deutsche X-trackers Investment Grade Bond – Interest Rate Hedged ETF (NYSEArca: IGIH) increased 5.3% and the ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG) returned 6.6% over the same period.
Investors can also look to rate-hedged high-yield bond ETFs, such as the Deutsche X-trackers High Yield Corporate Bond – Interest Rate Hedged ETF(NYSEArca: HYIH), iShares Interest Rate Hedged High Yield Bond ETF (NYSEArca: HYGH), Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY), ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG) and WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NYSEArca: HYZD).
Additionally, for more aggressive investors, the WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (NYSEArca: HYND) takes the process a step further, implementing an overweight short position on Treasuries to push to fund’s duration into the negatives. HYND shows a -6.95 year duration and a 5.77% 30-day SEC yield. Due to its negative duration, if interest rates were to rise 1%, the ETF could see a positive return of about 6.95%.
Related: 20 Hot Intermediate-Term Bond ETFs
However, potential investors should be aware that these zero- and negative-rate-hedged ETF strategies would only outperform non-hedged funds if interest rates and yields rise. In the event we experience heightened volatility or another rush into safe-haven Treasuries, these rate-hedged ETFs will underperform non-hedged ETFs due to their short Treasury positions. For instance, after the yields on 10-year Treasury notes dipped to 1.86% from 2.28% at the start of the year, LQD gained 5.3% while LQDH was only up 0.3%.
For more news and strategy on the Bond market, visit our Bond category.