Fixed-income investors have traditionally shifted down the yield curve when the Federal Reserve embarks on a tighter monetary policy to hedge against rate risk, but this comes with its own shortcomings. Alternatively, exchange traded fund investors may have a more appealing option through targeted interest-rate hedged strategies.
While investors may shift their fixed-income holdings to short-term bonds to diminish rate risk, they may not realize that they will be shortchanging their potential returns. Specifically, moving to short-term debt reduces rate risk but does not eliminate it, and short-term bonds have less exposure to credit opportunities, a key driver of returns, according to a ProShares note.
As an alternative to the traditional shift toward the short end of the yield curve, investors can eliminate rate risk and still maintain full exposure to credit opportunities through an interest rate-hedged bond ETF.