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WisdomTree Offers ETFs that Protect Against Rising Rates

Stocks in this article: AGG TBT AGZD AGND HYND HYZD

NEW YORK (TheStreet) -- WisdomTree Investments has had much success -- not only by issuing funds to attract funds investors, but also moving into new niches within the ETF industry. The company, of course, started out with dividend-focused funds then went on to take a dominant position in currency-hedged foreign ETFs. Its newest foray is four fixed-income funds, structured to offer protection when interest rates finally start to go higher.

The new funds include: 
          WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (HYND)
          WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (HYZD)
          WisdomTree Barclays US Aggregate Bond Negative Duration Fund (AGND)
          WisdomTree Barclays US Aggregate Bond Zero Duration Fund (AGZD)

The word duration in the name of these four funds refers to how sensitive the portfolio is to rising rates. The longer the duration the more sensitive the portfolio is. Zero duration targets no sensitivity to rising rates, hence neutralizing threats of rising rates by shorting treasury futures. Negative duration goes a step further by shorting treasury futures so that the fund would ideally go up when rates rise.

Interest rates have been low for many years, and logically after being low, rates will rise. That ultimate outcome was behind the launch of the ProShares Ultra Short 20+ Year Treasury ETF (TBT)

The ProShares funds simply sell short-treasury futures and will benefit when rates go up. However, they are not designed to pay income in the meantime. TBT can pay a dividend if the interest earned on cash in the fund exceeds the expense ratio, but TBT has not paid a dividend since 2008. TBT and similar funds hold onto cash to collateralize the short positions in treasury futures.

Where TBT is not really suited for income investors looking for protection, the new WisdomTree suite does just that. It should be noted that in recent months ProShares has come out with a couple of funds that also pair a bond portfolio with a hedge strategy to protect against rising rates including the ProShares Investment Grade Interest Rate Hedged ETF (IGHG).

To the WisdomTree funds, HYND and HYZD obviously target high-yield bond exposure by owning a portfolio of low- and non-rated bonds. An unhedged high-yield bond portfolio possibly takes on interest rate risks depending on the average maturity of the portfolio. But a high-yield portfolio also takes on the risk that bonds in the portfolio will default. According to MarketWatch the average default rate for high-yield debt over the last 20 years has averaged 4.5%, but has been running closer to 3% in recent years.

AGND and AGZD target a lower yielding but higher quality aggregate bond index along the lines of the one tracked by the iShares Core Total US Bond Market ETF (AGG)

It's too early for any definitive yield information, but IGHG paid its first dividend earlier this month after its November debut. The $0.19 dividend would annualize to 2.8% at the fund's current price and, while future dividends could easily fluctuate in either direction, it creates reasonable hope that the hedge employed by all these funds may not create an unreasonable drag on the yield.

It needs to be understood however that this sort of strategy is new under the hood of an ETF. As learned from this week's Fed press conference, they will not be increasing the rates under their control anytime soon -- which might give these new ETFs time to set realistic expectations for potential investors regarding how these funds will actually trade.

At the time of publication, the author held no positions in any of the funds mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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