“An alternative approach is to seek to eliminate interest rate risk while maintaining full exposure to credit opportunities. This is what an interest rate hedged strategy aims to do. It’s important because, when rates rise, credit spreads have typically tightened and boosted returns,” according to a ProShares note.
For instance, the ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG) tries to reflect the performance of the Citi Corporate Investment Grade Treasury Rate Hedged Index, which provides exposure to a diversified portfolio of investment-grade long-term bonds with a built-in interest rate hedge. The ETF will maintain full exposure to credit risk as a source of return while simultaneously incorporating a hedge to alleviate the impact of rising rates.
To achieve its lower rate risk exposure and maintain its return potential, IGHG takes short positions in U.S. Treasuries to achieve a zero duration target. With a zero duration, the bond ETF has no sensitivity to changes in interest rates, providing investors access to higher yields and outperforming other non-hedged bond funds with similar durations when rates rise.
For more information on the fixed-income markets, visit our bond ETFs category.