Investors are looking for the delicate balance between generating yield and not getting burned by rising interest rates.
For example, yields on the 10-year Treasury note climbed over 2.3% to the highest levels in over a year on Wednesday. Federal Reserve chief Ben Bernanke said the Fed may scale back its bond purchases later this year.
High-yield debt and other bonds have been hit by concerns over Fed “tapering” and the changing interest rate environment, but there are a couple of high-yield bond exchange traded funds that hedge against rising rates to a degree.
Two new bond ETFs, the ProShares High Yield-Interest Rate Hedged (HYHG) , which launched May 21, and the Market Vectors Treasury-Hedged High Yield Bond ETF (THHY) , which started trading March 21, provide fixed-income investors with exposure to high-yield debt, while attempting to limit duration risk. [These High-Yield Bond ETFs Protect Against Rising Rates]
Paul Paiocchi for Forbes points out that the two funds try to remove or at least mitigate interest-rate risk and isolate credit risk. In essence, if interest rates rise, spreads will remain relatively the same. Consequently, investors will still receive income but they won’t have to see their principal diminish due to rising interest rates.
The funds, though, will generate greater total returns if spreads tighten and will falter if spreads widen.
However, according to Market Vectors, this investment “presents significant risk of loss in ‘risk-off’ environment when U.S. Treasuries rally and high-yield bonds decline,” which makes sense since these ETFs take short positions in U.S. Treasuries. In essence, the two funds act like a long/short bond ETF strategy. [Using Inverse ETFs to Hedge Interest Rate Risk]
The ProShares High-Yield-Interest Rate Hedged fund tries to reflect the performance of the Citi High Yield (Treasury Rate-Hedged) Index, which provides exposure to a diversified portfolio of high-yield bonds and holds short positions in Treasury securities to hedge against rising rates. HYHG has a 0.50% expense ratio and the fund has a duration of effectively zero.
The underlying index also limits exposure so that no more than two issues from each issuer are allowed and no single issuer can make up more than 2% of the index.
Credit quality breakdown includes BB 43.7%, B 43.0% and CCC or lower 13.3%.
Sector allocations include industrial services 36.5%, industrial manufacturing 24.0%, industrial energy 17.0%, telecom 9.8%, industrial consumer 3.5%, utilities 3.3%, electric utilities 2.0% and finance 2.0%.
The Market Vectors Treasury-Hedged High Yield Bond fund tries to reflect the performance of the Market Vectors U.S. Treasury-Hedged High Yield Bond Index, which tracks U.S. denominated speculative grade debt and takes short positions in 5-year Treasury notes. Specifically, the fund offsets its long position with a 97.4% short position in U.S. Treasuries. THHY has a 1.45% expense ratio and a 3.31% 30-day SEC yield. The fund has an effective duration of 0.02 years.
Credit quality breakdown includes BB 38.0%, B 43.7%, CCC 15.1% and CC 0.7%.
Sector allocations include communications 23.3%, consumer non cyclical 17.3%, energy 15.3%, financial 14.0%, consumer cyclical 12.8%, utilities 5.7%, industrials 4.0%, technology 3.9% and basic materials 1.1%.
For more information on high-yield fixed-income assets, visit our high-yield bonds category.
Max Chen contributed to this article.
Story updated to correct information on how HYHG hedges its interest-rate exposure.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.