5 Tools To Manage Interest Rate Risk

December 16, 2015

5. The Hedger

Finally, there’s an emerging tool in the ETF investor fixed-income kit that’s quickly gathering a following: interest-rate-hedged funds.

What’s interesting about these types of ETFs—such as the Deutsche X-trackers Investment Grade Bond - Interest Rate Hedged (IGIH | F), the iShares Interest Rate Hedged Corporate Bond (LQDH | C) and a roster of other funds, is that they appeal more to wealth managers and institutions because they have derivatives built into them, Tucker says. LQDH, for example, owns bonds and interest-rate swaps to hedge interest rates.

“The idea here is that you get exposure to corporate bonds, but take out interest-rate risk from those securities,” Tucker said. “By doing that, you are giving up the yield you would receive on the risk, but you are still picking up some yield and maintaining exposure to a market—in this case, corporate bonds.”

Hedged ETFs, when used as part of an allocation that also includes unhedged ETFs, allow investors to be more precise about how much interest-rate risk they want exposure to, Tucker notes. The other key thing to remember with this approach is that you might be protected from interest-rate risk, but you will be highly exposed to credit risk tied to the corporate bond market.

Charts courtesy of StockCharts.com

Contact Cinthia Murphy at [email protected].

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