The debt market has been reeling as bond yields rose. However, fixed-income investors can hedge against rising rates through alternative bond exchange traded fund strategies.
On the recent webcast, The Growing Risk of Normalizing Interest Rates, Simeon Hyman, Head of Investment Strategy at ProShares, pointed to a targeted zero-duration bond fund strategy to diminish rate risks. Through a zero-duration strategy, investors would more or less negate the negative effects of rising interest rates on their bond investments.
Many advisors and investors have already turned to common hedging strategies like shorter-term duration bonds ahead of a potential rate hike. In a survey of financial advisors on the webcast, 93% of respondents believed that a December Federal Reserve rate hike is imminent, with 62% turning to short-duration funds as the go-to hedge.
“Rising rates can still significantly impact short-term bond funds,” Hyman warned. “A strategy that targets a duration of zero may have even less sensitivity – potentially no sensitivity – to rising interest rates. Of course, you can employ a method where you short out the duration exposure yourself as well.”
For example, the ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG) and ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG) hold short positions in interest rate swaps to provide about a 0 year effective duration – duration is a measure of a bond fund’s sensitivity to changes in interest rates so a zero duration reflects no sensitivity to changes. Consequently, the zero-duration strategy should help an interest-rate-hedged ETF outperform its non-hedged fund options if rates continue to rise.
“Combined, the long and short portfolios are designed to target a duration of zero at each monthly rebalancing,” Hyman said. “In this manner, the ETFs attempt to hedge out the interest rate risk of the long holdings, while leaving other drivers of risk and return unaffected.”