The recent market twirls resulting from worries over the steady cease in cheap-dollar flows, possibility of hike in interest rates and stock market volatility have left investors jittery about the safety of their portfolios and brought rate-rise worries back on the table.
Gauging this market sentiment, iShares launched two corporate bond ETFs which hedge interest rate risks. Both funds - Interest Rate Hedged Corporate Bond ETF under the symbol of LQDH and Interest Rate Hedged High Yield Bond ETF under the symbol of HYGH - hit the market on May 27, 2014.
LQDH & HYGH in Focus
The new actively managed ETFs look to reduce the interest rate risk of a portfolio made up of U.S. dollar-denominated corporate bonds (read: Forget Treasury Bonds, Try This Top Corporate Bond ETF Instead ). In order to minimize interest-rate risks, the funds take short exposure to U.S. treasury futures.
LQDH reduces interest rate risks and holds the bonds comprising iShares' ETF - iShares iBoxx $ Investment Grade Corporate Bond ETF ( LQD ). This exposure gives LQDH a long-term bond ETF status with a weighted average maturity of 11.53 years as of May 30, 2014.
But its negligible effective duration of 0.11 years confirms minimal interest rate risks. Thanks to the focus on investment grade bonds, LQDH carries low default risks too. For this exposure, LQDH charges a net expense ratio of 25 bps per year.
The other entrant to the ETF world is HYGH. This fund holds in its basket the iShares iBoxx $ High Yield Corporate Bond ETF ( HYG ) while taking short positions in U.S. Treasury futures to diminish rising rate concerns. HYGH has a weighted average maturity of 4.18 years while its effective duration stays ultra-low at 0.50 years. HYGH is high yield in nature as evident from HYG's 30-day SEC yield of 4.31%. HYGH charges 0.55% of expense ratio (see all the junk bond ETFs here ).
How could it fit in a portfolio?
With the U.S. economic indicators rebounding in Q2 and the Fed steadily withdrawing its QE support, rock-bottom interest rates in the U.S. could undergo hikes, sooner or later. At a time like this when investors are extremely cautious about rising rate risks and stock market volatility, investments in U.S. bonds having significant protection against potential rising rates can be a good bet. And to accomplish this investing goal, LQDH and HYGH come across as two of the best-suited products (read: 3 ETFs for Rising Interest Rates ).
These two funds will quench investor thirst for yield as well. Unlike short-duration funds which put a cap on interest rate risks but leave investors with meager yields, LQDH and HYGH only hedge for interest rates while gift investors with decent yields.
Among the two, investors looking for more safety should target LQDH (as this bears a high credit rating) while HYGH stays at the opposite end compensating investors with considerably higher yields.
There are ample choices both in the investment grade or junk corporate bond ETF spaces, but bond ETFs with a hedge against interest rates are very few in the market. In the high yield space, ProShares High Yield-Interest Rate Hedged ETF ( HYHG ), WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (HYZD) and Market Vectors Treasury-Hedged High Yield Bond ETF (THHY) are some the names that also take short positions in U.S. treasuries and might come in the way of HYGH's success.
Options are far less in the investment grade bond ETF space. Thus, LQDH should not face any hurdle in attracting investors' cash. However, LQDH might face some rivalry from the ProShares Investment Grade-Interest Rate Hedged ETF ( IGHG ) which too offers interest-hedge benefit to investors.
We expect both the newly launched funds to find some interest from investors as these have entered a still under-tapped investing arena. Either of the funds does not charge astronomically despite their actively managed approach. LQDH charges less than IGHG while expenses to own HYGH are lower than THHY. However, investors should note that the other two high-yield options are priced lower than HYGH.
Having said this, we would like to notify you that both LQDH and HYGH are modeled on the ultra-popular LQD and HYG. While LQD is a $17.8 billion fund, HYG has $13.5 billion under management. Thus, what could be better ways to have exposure to some already well-accepted ETFs along with reduced interest worries other than LQDH and HYGH?
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