Market Vectors index highlights appeal of interest rate hedged bond ETFs

Feb 9th, 2013 | By | Category: Fixed Income

Market Vectors Index Solutions has introduced the Market Vectors US Treasury-Hedged High Yield Bond Index, a new bond strategy index reflecting the performance of a long position in high-yield corporate bonds and a short position in US Treasuries.

New Market Vectors’ index highlights appeal of interest-rate hedged bond ETFs

Market Vectors’ new fixed income strategy index highlights the appeal of interest rate hedged bond ETFs.

The index comes at a time when investors are becoming increasingly conscious of the potential negative impact of interest rate rises on bond returns but are nonetheless still keen to exploit the enhanced income associated with high-yield debt.

Lars Hamich, CEO at Market Vectors Index Solutions, said: “After years and years of declining US interest rates, many investors have begun to contemplate what to do when the tide turns and interest rates rise.”

He added: “We therefore believe that the Market Vectors US Treasury-Hedged High Yield Bond Index benchmarks a segment of particular interest to investors. The combination of long and short components results in an index that tracks the marriage of these two investment goals: participation in high yield and interest rate protection.”

In terms of methodology, the index tracks the performance of long positions in below-investment grade corporate bonds (also known as junk bonds) denominated in US dollars and an equivalent US dollar amount of short positions in US Treasury notes. Included in the index are only securities issued by US-incorporated issuers that have a minimum of 12 months remaining to maturity, a fixed coupon schedule and a minimum amount outstanding of $500 million. The index is calculated as Total Return Index and is rebalanced monthly.

The index highlights the appeal of strategies that hedge interest rate risk, particularly at a time when interest rates essentially have only one direction to move in – upwards. Although the index is not yet tracked by an exchange-traded fund (plans to launch the Market Vectors High-Yield/Treasury Bond ETF have been filed with the SEC), investors are able to access this kind of strategy bundled into ETF format.

One option available to UK and European investors is the iShares Barclays Capital Euro Corporate Bond Interest Rate Hedged ETF (IRCP). The fund, which is listed on the London Stock Exchange (LSE), tracks the total return of euro-denominated corporate bonds, as measured by the Barclays Euro Corporate Bond Index, while hedging against underlying interest rate risk. The fund protects against interest rate rises by selling German government bond (bunds) futures contracts in order to target a portfolio duration of zero. The short position in bund futures contracts would profit from falling bond prices, a consequence of rising interest rates.

An alternative to the iShares fund is the db x-trackers II Markit CDX North America High Yield ETF (XH7Y). This LSE-listed fund takes a different approach, but achieves a broadly similar result. The fund allows investors to take on pure credit risk exposure – as opposed to the credit plus interest rate risk generated through investing in conventional bond indices – to the US high-yield bond market by tracking the performance of Markit credit default swap (CDS) indices. CDS indices reflect the return generated from selling credit protection. The net result is that investors can pick up the income associated with high yield but are not exposed to interest rate risk.

Sophisticated investors looking to take a more active approach could hedge interest-rate risk by deploying an inverse bond ETF. Inverse (or short) bond ETFs are offered by Amundi and db X-trackers, and are available on gilts, Treasuries and eurozone sovereign debt. US-based investors can explore inverse bond ETFs sponsored by ProShares and Direxion.

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