As fixed-income investors gear up for a rising rate environment ahead, some have already turned to rate-hedged bond exchange traded funds in an attempt to limit rate risk and still enjoy yield generation.
For example, the ProShares Investment Grade-Interest Rate Hedged ETF (BATS:IGHG) and ProShares High Yield Interest Rate Hedged ETF (BATS:HYHG), two rate hedged ETF strategies that try to eliminate the rising rate risks, have attracted $180 million and $50 million in net inflows, respectively, year-to-date, according to XTF data.
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. For example, IGHG shows a -0.03 year duration and a 3.31% 30-day SEC yield, and HYHG has a -0.08 year duration and a 5.21% 30-day SEC yield.
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.
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While yields have been pressured in recent weeks on political risks and the European Central Bank’s dovish stance on policy changes, fixed-income investors should keep in mind that the Federal Reserve is planning to reduce its $4.5 trillion bond hoard, which could lead to Treasury bonds being dumped onto the market and higher rates.
Furthermore, the Federal Reserve has already shown its willingness to achieve interest rate normalization. However, the headline inflation remains muted and the Fed is still waiting on inflation to reach its 2% target before making any more drastic changes.
For more information on the fixed-income market, visit our bond ETFs category.