How to Hedge Corporate Bond Exposure as Rates Rise

Investors looking to generate income with investment-grade corporate debt while gaining protection against rising interest rates have some options to consider in the world of exchange traded funds, including the ProShares Investment Grade-Interest Rate Hedged ETF (Cboe: IGHG).

IGHG, which debuted nearly five years ago, reduces rising rates risk 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. The ETF’s net effective duration is -0.28 years, according to ProShares data.

Although IGHG can hedge rate risk, that does not mean investors sacrifice yield. The fund has a 30-day SEC yield of 4.12%, which is inline with the yield on the Markit iBoxx USD Liquid Investment Grade Index. IGHG tracks the FTSE Corporate Investment Grade (Treasury Rate-Hedged) Index.

Minimal Credit Risk

While IGHG can help fixed income investors reduce interest rate risk, the ETF also skirts significant credit risk. To be included in IGHG’s lineup, bonds must have a minimum rating of BBB- from S&P and a Baa3 from Moody’s Investors Service.

At the end of the first quarter, over 40% of IGHG’s 350 holdings were rated A- or BBB+, according to issuer data. IGHG’s underlying index only allows two issues per issuer and caps individual issues at 3%.

Due to their near-zero durations, the rate-hedged bond funds should show little to no sensitivity to changes in interest rates. These types of hedged-bond ETFs could provide suitable exposure to the fixed-income market in a rising interest environment ahead.