Rising Treasury yields often prompt advisors and investors to embrace short-term bonds and related exchange traded funds, but there are other ideas to consider, including rate-hedged bond ETFs.
The ProShares Investment Grade-Interest Rate Hedged ETF (Cboe: IGHG) and ProShares High Yield Interest Rate Hedged ETF (Cboe: HYHG) are two rate hedged ETF strategies that try to eliminate rising rate risks.
Data confirm the utility of IGH and HYHG in the current environment.
“If, for example, 10-year U.S. Treasury yields rose just a half of a percent (still a low rate for 10-year yields), a typical investment-grade bond portfolio with a duration of 10 could see a five percent reduction in total return. And while short-term bond funds are an option to help reduce rate risk, they cannot eliminate it,” according to ProShares research.
Benefits Abound with Hedged Bond Funds
These rate-hedged bond ETFs maintain attractive yields when limiting their sensitivity to rising rates. By hedging away rate risk, bond investors can focus on the underlying debt securities without fear of the negative effects of rising interest rates, potentially capitalizing on the tightening credit spreads.
IGHG tracks the performance of the Citi Corporate Investment Grade (Treasury Rate-Hedged) Index with long positions in investment-grade corporate bonds issued by both U.S. and foreign domiciled companies. This is particularly important during market downturns when the propensity for a company to default on its debt is higher. As such, IGHG focuses on investment-grade issues to reduce credit risk.
HYHG “targets zero interest rate risk by including a built-in hedge against rising rates that uses short positions in U.S. Treasury futures,” according to ProShares.
Bond funds hold a collection of debt with varying maturities, buying and selling debt securities to maintain their short-, intermediate- or long-term strategy. When it comes to bond ETFs, investors should look at the duration, or a bond fund’s measure of sensitivity to gauge their investment’s exposure to changes in interest rates. A higher duration means higher sensitivity to shifts in rates.
“ProShares interest rate hedged bond ETFs, on the other hand, target zero interest rate risk. They combine portfolios of diversified corporate bonds, either investment grade or high yield, with built-in hedges against rising rates,” concludes the issuer.
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