Counter the Effects of Rate Hikes By Going Long in Duration

Another 75 basis point rate hike by the U.S. Federal Reserve is making short duration the ideal option when it comes to bonds to mitigate rate risk, but to mute the impact of rising rates, another option is to go far out on the yield curve.

“The farther you move out on the yield curve and the more you go down in credit quality, the less Fed rate hikes affect interest rates,” said certified financial planner Paul Winter, owner of Five Seasons Financial Planning.

Hesitant investors who don’t want to accept the higher credit risk can still go longer on the yield curve while staying in the safe confines of government debt. One way is to go the extra mile when it comes to duration via extended-duration Treasury notes.

What this essentially involves is going for Treasury notes with maturity dates within the 20- to 30-year range. This strategy can involve one exchange traded fund as opposed to holding a number of notes: the Vanguard Extended Duration Treasury Index Fund ETF Shares (EDV).

The ETF has a 30-day SEC yield of 3.71%, giving fixed income investors that extra yield they seek with a low expense ratio of 0.06%. As Winter mentioned, the effect of further rate increases by a hawkish Federal Reserve can be minimized by adding this type of long-duration exposure without sacrificing credit quality.

Stepping Far Out on the Yield Curve

Per the fund description, EDV seeks to track the performance of an index of extended-duration zero-coupon U.S. Treasury securities. The fund employs an indexing investment approach designed to track the performance of the Bloomberg U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index.

This index includes zero-coupon U.S. Treasury securities (Treasury STRIPS), which are backed by the full faith and credit of the U.S. government, with maturities ranging from 20 to 30 years. The fund invests by sampling the index. At least 80% of its assets will be invested in U.S. Treasury securities held in the index.

Highlights of EDV:

  • Seeks to track the performance of the Bloomberg U.S. Treasury STRIPS 20–30 Year Equal Par Bond Index.
  • Is passively managed using index sampling.
  • Provides current income with high credit quality.

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