Bond exchange traded fund investors can maintain yield generation and diminish the negative effects of rising rates on their investments through targeted interest-rate hedged strategies.
“As rates pressures rise, it may be time for investors to consider a move into interest-rate hedged exposure,” Luke Oliver, Head of ETF Capital Markets at Deutsche Asset Management, said in an email.
For instance, Deutsche Asset Management offers the Deutsche X-trackers Investment Grade Bond – Interest Rate Hedged ETF (NYSEArca: IGIH) and Deutsche X-trackers High Yield Corporate Bond – Interest Rate Hedged ETF (BATS: HYIH) to access investment- and speculative-grade corporate bonds while negating the negative effects of rising interest rates.
The two funds take long positions in corporate debt securities but also pare the exposure with short positions in U.S. Treasury securities of approximate equivalent duration to the corporate bonds in an attempt to maintain a near zero bond duration. With a near zero duration, the bond ETFs will exhibit little to no negative effect when interest rates rise, outperforming non-interest-rate hedged bond funds.
[related_stories]For instance, as yields on benchmark 10-year Treasury notes surged, the popular iShares iBoxx $ Investment Grade Corporate Bond ETF (NYESArca: LQD) declined 2.9% and iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG) dipped 0.2% over the past month. Meanwhile, IGIH rose 1.0% and HYIH gained 1.3%.
“Interest-rate hedged ETFs have significantly outperformed un-hedged peers this quarter,” Oliver added. “This outperformance has grown following the US election results and has been led by the market’s pricing in of higher long-end rates, on expectations of the new fiscal policy and inflation pressure. And looking to December, the market pricing probability of an interest-rate hike by the U.S. Federal Reserve Board has jumped to 96%.”
Many market observers and even Federal Reserve officials are expecting an interest rate hike at the Fed’s next meeting in December. Federal Reserve governor Jerome Powell was the latest to argue for raising interest rates.
The economy is “growing at a healthy pace, with solid payroll job gains, and inflation gradually moving up to 2%,” Powell said on Tuesday, arguing that the case for raising rates has “clearly strengthened” since the Federal Open Market Committee decided to leave rates unchanged at its early November meeting, according to the Dow Jones Newswire.
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