Three types of ETFs that can help with rising rates


Karen Veraa, CFA Mar 29, 2022

BOND YIELDS ON THE MOVE

As widely anticipated, the Federal Reserve raised the Fed Funds rate by 0.25% to 0.25%-0.50% during the March Federal Open Market Committee (FOMC) meeting, its first interest rate hike since December 2018. The Federal Reserve has a dual mandate; keeping prices stable (i.e. managing inflation) and keeping the economy running at full employment.  The central bank increased the Fed Funds rate to try and stay consistent with these goals:

  1. Stable inflation: Higher interest rates have historically helped curb high inflation.
  2. Full employment: Many jobs have been created as the economy continues to recover from the impacts of the global pandemic, affording the Fed leeway to raise interest rates to a level they believe won’t hurt economic activity and job creation.

In addition to the Fed Funds rate increasing, longer-term rates have increased as the market anticipates the path of future rate hikes. Interest rate increases can have a significant impact on bond investments, since bond prices fall when interest rates rise. However, bonds play a crucial role in portfolios, as potential diversifiers and income generators.

Fed funds rate vs 10 year U.S. Treasury rate

Line chart comparing the federal funds rate and 10 year U.S. treasury yield from 1998 through March 2022

Source: Bloomberg. As of 03/25/2022. The 10-Year Treasury index is represented by the Bloomberg 10-20 Yr U.S. Treasury Index. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.


HOW CAN BOND INVESTORS AIM TO PROTECT PORTFOLIO VALUE IN A RISING RATE ENVIRONMENT?

Bond ETFs are a low-cost way to help mitigate interest rate risk in your portfolio. Investors may want to consider the ETFs listed below to hedge against rising interest rates and complement or replace existing bond holdings.

Interest Rate Hedged ETFs: iShares Interest Rate Hedged Long-Term Corporate Bond ETF (IGBH) and iShares Interest Rate Hedged High Yield Bond ETF (HYGH) provide a cost effective way to seek to mitigate interest rate risk through a fund of funds structure that utilizes interest rate swaps, which reduce exposure to interest rate risk while maintaining credit exposure. 

Floating Rate Note ETFs:  iShares Floating Rate Bond ETF (FLOT) and iShares Treasury Floating Rate Bond ETF (TFLO) provide exposure to U.S. floating rate bonds and U.S. floating rate Treasury bonds, whose interest payments adjust to reflect changes in interest rates. The floating rate notes in FLOT and TFLO tend to have lower duration than fixed securities due to the frequent interest rate resets. 

Short Maturity Fixed Rate ETFs:  iShares 1-5 Year Investment Grade Corporate Bond ETF (IGSB) and iShares Core 1-5 Year USD Bond ETF (ISTB) hold fixed rate bonds with 1-5 years to maturity profiles, which currently provides reduced duration relative to broader maturity indices. IGSB invests in short-term U.S. investment grade corporate bonds, while ISTB invests in multi-sector short-term core bonds. In addition to taxable fixed income, investors can also seek to shorten duration of municipal bond portfolios with iShares Short-Term National Municipal Bond ETF (SUB) and BlackRock Short Maturity Municipal Bond ETF (MEAR).

Rising rates can weigh on bond returns. By allocating to interest rate hedged, floating rate, and shorter duration exposures, investors can help insulate their bond investments against rising rates.

Karen Veraa, CFA

Karen Veraa, CFA

Head of U.S. iShares Fixed Income Strategy