With the Federal Reserve signaling it will embark on interest rate normalization with more hikes to come, fixed-income investors can still maintain their attractive payouts without shifting down the yield curve through rate-hedged bond exchange traded funds.

Bond investors would usually move down the yield curve to hedge against rising interest rate risks as a lower duration bond fund would have a lower sensitivity to changes in interest rates. However, while moving down the yield curve provides a greater level of safety, lower duration bond funds come with less appealing yields.

Investors, though, do not need to sacrifice yields to diminish rate risk. Alternatively, investors can look to rate-hedged or zero-duration bond ETFs. The group of interest rate-hedged or zero duration ETFs hold long-term bonds but also simultaneously short Treasuries or Treasury futures contracts to hedge against potential losses if interest rates rise.

Due to their near-zero durations, the rate-hedged bond funds should show little to no sensitivity to changes in interest rates. These types of hedged-bond ETFs could provide suitable exposure to the fixed-income market in a rising interest environment ahead.

For instance, 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 -0.01 effective duration, whereas the popular iShares iBoxx $ Investment Grade Corporate Bond ETF (NYESArca: LQD) has a 7.91 year duration. Additionally, the rate-hedging strategy does not sacrifice too much in yields as LQDH shows a 3.06% 30-day SEC yield, compared to LQD’s 3.54% 30-day SEC yield. The strategy should help an interest-rate-hedged ETF outperform its non-hedged options if rates continue to rise.

Investors who are interested in the rate-hedged bond strategy have a number of other ETF options available.

Interest Rate-Hedged ETFs:

  • Deutsche X-trackers Investment Grade Bond – Interest Rate Hedged ETF (NYSEArca: IGIH)
  • Deutsche X-trackers High Yield Corporate Bond – Interest Rate Hedged ETF(NYSEArca: HYIH)
  • Deutsche X-trackers Emerging Markets Bond – Interest Rate Hedged ETF (NYSEArca: EMIH)
  • iShares Interest Rate Hedged Corporate Bond ETF (NYSEArca: LQDH)
  • iShares Interest Rate Hedged Emerging Markets Bond ETF (NYSEArca: EMBH)
  • iShares Interest Rate Hedged 10+ Year Credit Bond ETF (NYSEArca: CLYH)
  • iShares Interest Rate Hedged High Yield Bond ETF (NYSEArca: HYGH)
  • Market Vectors Treasury-Hedged High Yield Bond ETF (NYSEArca: THHY)
  • ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG)
  • ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG)
  • WisdomTree Barclays U.S. Aggregate Bond Zero Duration Fund (NYSEArca: AGZD)
  • WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NYSEArca: AGND)
  • WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NYSEArca: HYZD)
  • WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (NYSEArca: HYND)

For more information on the fixed-income markets, visit our bond ETFs category.