With the economy expanding and the Federal Reserve set on normalizing its interest rate policy, fixed-income investors may consider an interest-rate hedged bond ETF to limit rate risks and still generate attractive yields.
For example, the ProShares Investment Grade-Interest Rate Hedged ETF (BATS: IGHG) and ProShares High Yield Interest Rate Hedged ETF (BATS: HYHG) are two rate hedged ETF strategies that try to eliminate the rising rate risks. IGHG shows a 0 year net effective duration and a 3.39% 30-day SEC yield while HYHG has a -0.04 year duration and a 5.93% 30-day SEC yield.
The two rate-hedged bond ETFs achieve their diminished rate-risk status by shorting Treasury notes so that the underlying portfolio shows a near-zero duration – duration is a measure of sensitivity to changes in interest rates, so a zero duration translates to no sensitivity to changes.
Consequently, these rate-hedged bond ETFs do not have to sacrifice their attractive yields when limiting their sensitivity to rising rates, allowing investors to still generate income without having to move down the yield curve. By hedging away rate risk, bond investors can focus on the underlying debt securities without fear of the negative effects of rising interest rates, maintaining their current level of income generation and potentially capitalizing on the tightening credit spreads.
In its latest official meeting, the Federal Reserve said it expected faster economic growth and lower unemployment next year as the economy strengthens and Congress likely to implement tax cuts for businesses and families. Consequently, given the healthier economic outlook, the Fed could step out with higher interest rates ahead.
“At the moment, the U.S. economy is performing well,” Fed Chair Janet L. Yellen said during her final Fed news conference earlier in December. “There’s less to lose sleep about now than has been true for quite some time.”
With the economy chugging along and the Fed likely to hike rates ahead, investors should think about rate-hedged bond ETFs, like IGHG and HYHG, for a diversified fixed-income portfolio.
For more information on the fixed-income market, visit our bond ETFs category.