[This ETF Industry Perspective is sponsored by ProShares.]
Preparing For A Rising Rate Environment
The recent run of good economic data and the promise of a COVID-19 vaccine suggest a period of rising interest rates could be on the way. Even a minor rate increase could be a significant drag on returns in corporate bond portfolios.
To prepare for rising interest rates, many investors move to short-term bond funds. This may help reduce their interest rate risk, but it doesn’t eliminate it. Is there a way to virtually eliminate it? There is—by targeting zero interest rate risk with interest-rate-hedged bond funds.
Targeting Zero Interest Rate Risk
One example is ProShares Investment Grade—Interest Rate Hedged ETF (IGHG), which tracks the FTSE Corporate Investment Grade (Treasury Rate-Hedged) Index, a diversified portfolio of investment-grade bonds with a built-in hedge against interest rate risk. The index maintains exposure to credit opportunities as a primary source of return, while the hedge is designed to alleviate the drag on return when interest rates rise. The index has a history of performing well during periods of rising rates.
IGHG's Index Outperformed Typical- and Short-Duration
Bond Indexes When Rates Rose
(For a larger view, click on the image above)
(For a larger view, click on the image above)
Source: Bloomberg. Average performance based on quarterly changes in the 10-year Treasury yield. Rising rate periods are any calendar quarter where the 10-year Treasury yield increased, which are Q2 2015, Q4 2015, Q3 2016, Q4 2016, Q3 2017, Q4 2017, Q1 2018, Q2 2018, Q3 2018, Q4 2019, Q3 2020 and Q4 2020. As of 12/31/20, the duration of the FTSE Corporate Investment Grade (Treasury-Rate Hedged) Index was 0.23 years. Duration is a measure of a fund’s sensitivity to interest rate changes, reflecting the likely change in bond prices given a small change in yields. Higher duration generally means greater sensitivity. The Markit iBoxx USD Liquid Investment Grade Index is designed to provide a balanced representation of the USD investment-grade corporate market and to meet the investor's demand for a USD-denominated, highly liquid and representative investment-grade corporate index. The index represents typical duration for the broad investment-grade bond market. The Bloomberg Barclays U.S. 1–5 Year Corporate Bond Index measures the investment return of U.S.-dollar-denominated, investment-grade, fixed rate, taxable securities issued by industrial, utility, and financial companies with maturities between one and five years. Index returns are for illustrative purposes only and do not represent fund performance. Index performance returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged, and one cannot invest directly in an index. For IGHG's standardized returns and performance data current to the most recent month end, see Performance.
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 5% reduction in total return. And while short-term bond funds are an option to help reduce rate risk, they cannot eliminate it.
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.
Short-term bond funds are not the only answer to rising rates. Another way to remain invested in bonds is to remove the interest rate risk entirely with a built-in hedge. If rates begin to rise, now may be a good time to prepare with an interest-rate-hedged bond ETF. For more information, visit ProShares.com.
Investing is currently subject to additional risks and uncertainties related to COVID-19, including general economic, market and business conditions; changes in laws or regulations or other actions made by governmental authorities or regulatory bodies; and world economic and political developments.
Investing involves risk, including the possible loss of principal. These ProShares ETFs are diversified and entail certain risks, including risks associated with the use of derivatives (swap agreements, futures contracts and similar instruments), imperfect benchmark correlation, leverage and market price variance, all of which can increase volatility and decrease performance. Bonds will decrease in value as interest rates rise. Short positions in a security lose value as that security's price increases. Narrowly focused investments typically exhibit higher volatility. Please see summary and full prospectuses for a more complete description of risks. There is no guarantee any ProShares ETF will achieve its investment objective.
IGHG does not attempt to mitigate factors other than rising Treasury interest rates that impact the price and yield of corporate bonds, such as changes to the market's perceived underlying credit risk of the corporate entity. IGHG seeks to hedge investment-grade bonds against the negative impact of rising rates by taking short positions in Treasury futures. These positions lose value as Treasury prices increase. Investors may be better off in a long-only investment than investing in IGHG when interest rates remain unchanged or fall, as hedging may limit potential gains or increase losses. The short positions are not intended to mitigate credit risk or other factors influencing the price of the bonds, which may have a greater impact than rising or falling interest rates. No hedge is perfect. Because the duration hedge is reset on a monthly basis, interest rate risk can develop intra-month, and there is no guarantee the short positions will completely eliminate interest rate risk. Furthermore, while IGHG seeks to achieve an effective duration of zero, the hedges cannot fully account for changes in the shape of the Treasury interest rate (yield) curve. IGHG may be more volatile than a long-only investment in investment grade bonds. Performance of IGHG could be particularly poor if investment-grade credit deteriorates at the same time that Treasury interest rates fall. There is no guarantee the fund will have positive returns.
Carefully consider the investment objectives, risks, charges and expenses of ProShares before investing. This and other information can be found in their summary and full prospectuses. Read them carefully before investing. Obtain them from your financial professional or visit ProShares.com
"FTSE®" and "FTSE Corporate Investment Grade (Treasury Rate Hedged)" have been licensed for use by ProShares. FTSE is a trademark of the London Stock Exchange Plc and The Financial Times Limited and is used by the FTSE International Limited ("FTSE") under license. ProShares have not been passed on by FTSE or its affiliates as to their legality or suitability. ProShares based on the FTSE Corporate Investment Grade (Treasury Rate Hedged) Index are not sponsored, endorsed, sold or promoted by FTSE or its affiliates, and they make no representation regarding the advisability of investing in ProShares. THIS ENTITY AND ITS AFFILIATES MAKE NO WARRANTIES AND BEAR NO LIABILITY WITH RESPECT TO PROSHARES.
ProShares are distributed by SEI Investments Distribution Co., which is not affiliated with the funds' advisor.