If there ever was a time for interest rate-hedge bond funds to prove their value, this year is it. They appear to have won the battle but lost the war, columnist MktwHulbert writes.
I’m referring to funds that hedge against rising interest rates. I’ve written about such funds before, when the prospect of higher rates—and the value of rate-hedged bond funds—was mostly theoretical. I concluded that such funds could be attractive to extremely risk-averse fixed-income investors.
To assess how they did, I will focus on the iShares Interest Rate Hedged Corporate Bond ETF LQDH, +0.51%. We know exactly how this ETF’s hedges impacted performance because an unhedged version also exists: The iShares iBoxx $ Investment Grade Corporate Bond ETF LQD, +0.64%. The other reason is that hedging isn’t costless; its expenses approach an annualized percentage point. So even when hedging works as designed, you nevertheless should expect to forfeit a good amount of interest income. Currently, for example, the LQD’s SEC yield is 3.80%, in contrast to 2.67% for the LQDH.
If you’re willing to hold a bond ladder for long enough, its total return almost certainly will be close to or equal its initial yield. The required length of time, according to the bond analysts who derived the formula, is one year less than twice the bond ladder’s duration. With a duration of 9.3 years, according to Morningstar, you therefore would need to own this ETF for 17.6 years in order that your return will match its initial yield.
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