So far, 2018 has not been an easy year for high-yield bond ETFs. The two largest funds in the segment—the $15 billion iShares iBoxx $ High Yield Corporate Bond ETF (HYG) and the $9 billion SPDR Bloomberg Barclays High Yield Bond ETF (JNK)—have faced sizable asset outflows as investors fret over high valuations and rising interest rates.
But there’s an ETF in this segment that seems to be thriving in these troubled waters, bucking the redemptions trend by gaining modest assets instead. It’s the iShares Interest Rate Hedged High Yield Bond ETF (HYGH).
Source: FactSet data
HYGH isn’t the only rate-hedged ETF on the market, but it offers here a great example of how these types of strategies are constructed and how they perform in the rising rate environment we are seeing.
Consider that from a performance perspective, HYGH has outperformed its massive, well-established nonhedged competitors this year, registering the lone gain for the year of the three.
Behind HYGH’s relative resilience is its unique interest-rate-hedged portfolio. So far in 2018, 10-year Treasury yields have risen about 0.45% to 2.87%. Going back 12 months, yields were around 2.45%. When interest rates rise—yields rise—the value of Treasuries declines. If you were to short Treasuries, you would profit from that value decline.
HYGH essentially shorts Treasuries by holding a portfolio of interest rate swaps against an allocation to HYG. The swaps bring down the duration of the overall portfolio to near zero, compared with HYG’s 3.86-year duration, all the while keeping a similar yield profile.
The longer the duration, the more sensitive a bond portfolio is to interest rate changes, so HYGH’s much shorter duration is its protection against higher rates. (The yield difference between HYGH and HYG depends on the absolute level of interest rates as well as the rate of change in interest rate movements, according to BlackRock.)
HYGH currently holds about $298 million in notional amounts of interest rate swaps against a $255 million position in HYG, a near 50-50 split, BlackRock says.