The Federal Reserve’s efforts to normalize monetary policy via higher interest rates is hampering high-yield corporate debt and some of the related exchange traded funds this year. However, income-hungry investors can remain engage with junk bonds with funds that also deliver reduced interest rate risk.
That includes the WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NYSEARCA: HYZD). HYZD, which turns five years old in December, follows the BofA Merrill Lynch 0-5 Year US High Yield Constrained, Zero Duration Index.
The fund “utilizes an Institutional style approach that combines long positions in bonds representative of the BofA Merrill Lynch 0-5 year US High Yield Bond Index with a short position in Treasury securities to target zero duration,” according to WisdomTree.
Coping With Higher Rates
The Federal Reserve has raised interest rates twice this year and many bond market observers believe another two rate hikes will be announced before the end of 2018.
Bond investors would usually move down the yield curve to hedge against rising interest rate risks as a lower duration bond fund would have a lower sensitivity to changes in interest rates. However, while moving down the yield curve provides a greater level of safety, lower duration bond funds come with less appealing yields.
Related: How to Best Invest in High-Yield With a Hedge
Investors, though, do not need to sacrifice yields to diminish rate risk. Alternatively, investors can look to rate-hedged or zero-duration bond ETFs. The group of interest rate-hedged or zero duration ETFs hold long-term bonds but also simultaneously short Treasuries or Treasury futures contracts to hedge against potential losses if interest rates rise.
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.
HYZD has an effective duration of -0.14 years and a 30-day SEC yield of 5.27%, indicating that while the fund reduced rate risk, it does not rob investors of income.
Over 82% of HYZD’s holdings are rated BB or B. The ETF also allocates nearly 11% of its weight to highly speculative CCC-rated bonds. HYZD charges 0.43% per year, or $43 on a $10,000 investment.
For more information on the fixed-income space, visit our bond ETFs category.