Matsui found that the change in U.S. Treasury rates needed to erase the yield advantage over the interest-rate hedged index is only 19 basis points – U.S. Treasury yields only need to fall 19 basis points to drag the price down 1.6% on a bond fund with a 8.5 year duration, negating the yield benefit of the non-hedged bond fund over the rate-hedged bond fund.
To better illustrate the point, the hedged index outperformed the non-hedged index by 3.75% between November 8 through November 30 when Donald Trump’s presidential election win caused 10-year rates to rise over 50 basis points.
Given Trump’s expansionary policies, we may expect further rate hikes out of the Fed, which will further weigh on bond funds with long durations.
“With the Trump administration’s promise to cut regulation, invest in infrastructure and cut taxes for individuals and businesses, inflationary pressures may soon be on the rise,” Matsui added. “Also, the unemployment rate is back to pre-crisis lows and wage growth is picking up. With inflation picking up steam, higher rates are likely to follow.”
DeAM has three interest-rate hedged bond ETFs, including 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).
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 to achieve a near zero year duration.
For more information on the fixed-income market, visit our bond ETFs category.