These ETFs Reduce Interest Rate Risk

Some fixed income exchange traded funds are languishing amid the Federal Reserve's 2018 rate tightening plans, prompting investors to depart some longer-dated, traditional bond ETFs.

“Despite growing demand for bond ETFs in 2018, one of the industry’s oldest and largest products is among the least popular this year,” CFRA Research Director of ETF & Mutual Fund Research Todd Rosenbluth said in a Monday note. “A nearly 5% decline and high sensitivity to rising interest rates is a likely driver of the outflows, yet we find it surprising that investors have not gravitated toward some of the better performing, lower-risk alternatives with the same investment-grade style.”

What Happened

While it's not surprising investors have departed some rate-sensitive bond ETFs, such as the iShares iBoxx USD Investment Grade Corporate Bond ETF LQD, it may be surprising investors are not yet swooning for rate-hedged equivalents.

LQD, the largest investment-grade corporate bond ETF, “had approximately $5 billion of redemptions this year, placing it among the industry’s ten biggest outflows,” said Rosenbluth.

“The fund, which recently had 50% of its assets in bonds rated BBB or equivalent according to CFRA Research, has been hurt by its 8.3 years of average duration. A key measure of risk for bond investors, duration tells investors how sensitive an investment is to a change in interest rates.”

The ProShares Investment Grade-Interest Rate Hedged ETF IGHG and the Xtrackers Investment Grade Bond - Interest Rate Hedged ETF IGIH are among the ETFs that can help investors remain engaged with credit opportunities while reducing interest rate risk.

Why It's Important

“The $480 million IGHG was up 0.2% this year, helped by a zero-duration portfolio,” said Rosenbluth. “The ProShares ETF tracks a different FTSE Corporate Investment Grade index and had a lower 44% of assets in BBB rated bonds and more in higher-grade securities.”

To be precise, IGHG has a net effective duration of -0.14 years, but even with that negative duration, the fund has a solid 30-day SEC yield of 4.12 percent. Investors have added $81.64 million to IGHG year-to-date, as of Oct. 26. At the end of the third quarter, IGHG had $528.29 million in assets under management.

What's Next

The Xtrackers Investment Grade Bond - Interest Rate Hedged ETF tracks the Solactive Investment Grade Bond - Interest Rate Hedged Index.

IGIH “recently had 46% of assets in bonds rated BBB. Meanwhile, the ETF had an average duration of 0.19 years, meaning it had a slightly positive sensitivity to rising rates. IGIH recently sported a 3.8% yield,” said Rosenbluth.

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