What the Hedge? How Are These Bond ETFs Holding Up So Well?

With the yield on the 10-year Treasury bond spiking approximately 150 basis points in 2022, advisors experienced double-digit declines in the value of some extremely popular fixed income ETFs.

For example, the $82 billion iShares Core Aggregate Bond ETF (AGG) dropped 10% year-to-date through May 9, while the $33 billion iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) fell 16%. While both ETFs own investment-grade bonds, the funds were hurt by the interest rate sensitivity of these securities. In particular, LQD’s average duration of 8.7 years provides elevated risk as the Federal Reserve is in the midst of its rate-hiking program. When interest rates rise, bond prices inside an ETF decline in value, particularly when the duration is high. 

As we previously noted, some advisors looking for alternatives within the fixed income ETF universe in 2022 have turned to short-duration or floating-rate ETFs such as the WisdomTree Floating Rate Treasury Fund (USFR) and the SPDR Bloomberg Investment Grade Floating Rate ETF (FLRN). However, there are funds sporting more compelling yields alongside similar investment-grade credit exposure to AGG and LQD.

The WisdomTree Interest Rate Hedged U.S. Aggregate Bond Fund (AGZD) was down just 1.0% year-to-date through May 9, outperforming the unhedged AGG by 900 basis points. While AGZD has pulled in approximately $150 million in assets, the ETF still has less than $400 million in assets overall. 

The iShares Interest Rate Hedged Corporate Bond ETF (LQDH) declined 4.4%, which was more than 1,200 basis points less than LQD. While LQDH is larger than some might realize, with $1.2 billion in assets, it has only pulled in $195 million so far this year.

These ETFs use futures contracts so the underlying portfolio shows a near-zero duration. By hedging away the interest rate risk, advisors can focus on the underlying bonds to maintain income generation and potentially benefit from tightening credit spreads. If the U.S. economy avoids a recession, corporate bond prices could climb higher in 2022. 

There are also interest rate-hedged ETFs focused on the speculative-grade bond market, such as the iShares Interest Rate Hedged High Yield Bond ETF (HYGH) and the ProShares High Yield Interest-Rate Hedged ETF (HYHG). While high yield bonds tend to be less rate-sensitive than investment-grade-focused products, advisors can avoid the concern with such products. 

Rather than forgoing yield or even shifting away from fixed income ETFs as the Fed continues to hike rates over the next 12 months, funds like AGZD and LQDH can support asset allocation strategies.

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