The June jobs report released last Friday revealed better-than-forecasted job growth with 213,000 jobs created, 9.23 percent better than the forecasted 195,000, which signals more economic growth that could spark more interest rate hikes–an environment that is rife for a fixed-income ETF like iShares Interest Rate Hdg Hi Yld Bd ETF (NYSEArca: HYGH) to thrive.
Per MarketWatch, the “June employment report gives the Federal Reserve a green light to continue to raise interest rates at what’s been shown to be its preferred once-every-three-months pace, economists said Friday.”
Interest Rate Risk Hedging
The prime focus of HYGH is to mitigate the interest rate risk of a portfolio composed of U.S. dollar-denominated, high yield corporate bonds. In order for HYGH to achieve its investment objective, it invests 80 percent of its net assets in U.S. dollar-denominated high yield bonds and also incorporates short positions in U.S. Treasury Securities.
Related: Rate Decline Could be Fueling Mortgage ETF REM
45.84 percent of HYGH’s holdings include yields tied to a fixed-income portfolio of bonds with a BB credit rating and another 40 percent with a B credit rating–more credit risk in lieu of higher yields as opposed to bonds with credit ratings higher than BB. As an example, high yield bonds with a BB credit rating have generated returns of 23.5 percent according to the ICE BofAML US High Yield BB Effective Yield index below.
While HYGH may take on more credit risks, the higher yields offered in the bond portfolio help shield investors from short-term rate rises that economists expect in the forthcoming months.
Related: Investors Flocked to Fixed-Income ETFs in June
Short Treasury Securities
According to an article in Reuters, only 25 percent of existing government bonds are trading above par value. The majority of government debt offered at a discount further points to a high-interest rate environment and investors are seeking higher yields.
Upon further inspection of the 10-year Treasury note, its yield has fallen flat after reaching a high of 3.11 percent in the middle of May. Since then, its yield has fallen by 8.04 percent.
By incorporating a long high-yield, short Treasury strategy, HYGH has been a stellar performer. Even in spite of the trade disputes between the United States, China and European Union having far-reaching effects on all capital markets, HYGH is up 1.86 percent year-to-date, 4.28 percent the past year and 4.93 percent in the past three years.
For more trends in fixed income, visit the Fixed Income Channel.