How to Best Invest in High-Yield With a Hedge
This article was originally published on ETFTrends.com.
Amid expectations that the Federal Reserve will continue raising interest rates this year, some fixed income investors are growing skittish with high-yield corporate debt and the related ETFs.
Corporate debt is reaching its highest level since before the financial crisis, which has caused Moody’s to warn that substantial trouble is ahead for junk bonds when the next downturn arrives.
The iShares Interest Rate Hedged High Yield Bond ETF (HYGH) offers investors an avenue for sticking with junk bonds while hedging interest rate risk. The actively managed HYGH holds the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG ) , the largest junk bond ETF, as well as short positions in interest rate swaps.
Low Duration to Traditional Junk Bonds
HYGH significantly lowers duration relative to traditional junk bonds like HYG. The former has an effective duration of just 0.21 years compared to 3.80 years on HYG. 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.
Related: ETF Investors Turn Risk-Off, Fleeing Toward Fixed-Income
Nearly 46% of HYGH’s holdings include yields tied to a fixed-income portfolio of bonds with a BB credit rating and another 40 percent with a B credit rating–more credit risk in lieu of higher yields as opposed to bonds with credit ratings higher than BB.
Although HYGH manages interest rate risk, its yield is inline with traditional junk bond funds. For example, the rate-hedged fund has a 30-day SEC yield of 5.79%, the same yield that is found on the unhedged HYG. HYGH's three-year standard deviation of 5.48% is slightly higher than HYG's.
HYGH debuted just over four years ago and has $322.26 million in assets under management. It charges 0.54% per year, or $54 on a $10,000 investment.
For more information on the fixed-income market, visit our bond ETFs category.
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