This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Clayton Fresk, CFA, portfolio management analyst at Georgia-based Stadion Money Management.
Interest rates are going to climb. It seems inevitable. However, the timing of when they will rise and the velocity with which they will rise is an issue of constant debate.
When rates finally do move higher, many fixed-income investors may be privy to price depreciation they have not experienced nor expected to experience from a “safe” asset class.
Based on recent issuance, it seems one of the ETF marketplace’s solutions to confront this price depreciation problem is interest-rate-hedged products. There is a plethora of them to choose from covering varying markets. What follows is my examination of 10 of these ETFs; their advantages and disadvantages; and other potential strategies an investor can use to protect against rising rates.
As of today, the high-yield market has the most interest-rate-hedged versions available, with five different issuers having products available:
- HYIH – Deutsche X-trackers High Yield Corporate Bond Interest Rate Hedged ETF (HYIY)
- HYGH – iShares Interest Rate Hedged High Yield Bond ETF (HYGH | C-44)
- THHY – Market Vectors Treasury-Hedged High Yield Bond ETF (THHY | F-45)
- HYHG – ProShares High Yield - Interest Rate Hedged ETF (HYHG | C-37)
- HYZD – WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (HYZD | D-61)
While mostly attempting to offer similar exposures, each of these offerings varies slightly from one another, whether it is from the underlying index it tracks or the method to which each hedges the interest rate exposure.
The underlying index differentials are no different from any other ETFs that track different indexes, so I’ll focus briefly on the hedging mechanism/weights that each of the aforementioned uses. The following are the percentage of notional weights in the two-, five-, 10-year or long bond futures (as of April 10 holdings):
|2 Year||5 Year||10 Year||Long Bond|
I should note that HYZD tracks a short-duration high-yield index, so the makeup of its hedge will naturally be different from the others, all of which track broad high-yield indexes.
THHY is different from its competitors in that it uses only five-year Treasury futures, whereas the others use futures across the curve. But among the other three, while the futures used are the same, the weightings are different. While, on its face, these weights are not massively different, they can be a source of performance differential between the names based on the shape of the yield curve during a potential rate increase.