As yields on 10-year U.S. Treasuries nearly touched 3 percent on Thursday for the first time since July 2011, interest rate risk remains a very real concern for fixed income investors, according to Fran Rodilosso, Fixed Income Portfolio Manager at Market Vectors ETFs.
“The concept of the Fed beginning to taper asset purchases has, in my opinion, not only been the trigger for the normalization of Treasury yields, but also the primary cause of recent outflows and volatility in a variety of markets, including high yield and emerging markets debt,” said Rodilosso. “Even though these markets remain exposed to rising interest rates, I believe some value has crept back into many of these markets.”
“In any case, I still see rising interest rates as the key risk for fixed income investors, as U.S. Treasury yields have been kept artificially low by non-market forces in the form of pure central bank intervention,” he continued. “Reducing this interest rate risk has typically meant lowering portfolio duration*, but that typically has come at the expense of lower income potential.”
One approach that Rodilosso pointed to that has historically proven to be an effective means of defending against higher rates while still generating some income for a portfolio has been a Treasury-hedged approach. Market Vectors offers the Treasury-Hedged High Yield Bond ETF (NYSE Arca: THHY), which by seeking to track its benchmark index, provides a hedge against rising interest rates by combining the more liquid portion of the high-yield bond universe with short positions in 5-year U.S. Treasury notes.While the 10-year Treasury’s yield at 3 percent is currently the headline grabbing news, the high yield market historically has averaged a duration much closer to that of the 5-year U.S. Treasury note. Rodilosso continued, “And, until a few weeks ago, 5-year yields were not going up as rapidly as 10-year yields, which was better for high-yield investors. However, since August 19, the 5-year yield has been moving higher more rapidly than that of the 10-year by about 13 basis points. When you consider that the 5-year U.S. Treasury Note’s yield reached 1.75 percent today, that move certainly does not seem high, or even normal, from a historical perspective.”