ETF Insights

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The benefits of hedging

Is interest rate hedging the solution to impending rate hikes?

The benefits of hedging

Interest rates have nowhere to go but up at this point. And as we discussed previously, signs point to an impending hike in rates by the Fed.

Investors need to take notice of the risks inherent in a rate hike. Data shows that sensitivity to interest rate changes is currently at a record high. In such a low yield environment, any capital losses from interest rate increases are going to be difficult to recoup.

As we’ve seen, there are a couple of solutions to minimizing interest rate risk. One of them is interest rate hedging. But how has this solution worked in the past?

We took a look at three bond indices (Barclays US Corporate Duration Hedged Bond Index, Barclays US Corporate Bond Index and Barclays US Corporate 1-5 Year Term Bond Index) to see how hedging performed from May 2003 to June 2006 when the Fed fund rate grew, comparing it with a longer period of generally declining rates.

During the shorter period of rising rates, the hedged index outperformed the unhedged, performing about the same as the short-term index. During the longer period of declining rates, the unhedged long-term index performed best.

So, interest rate hedging appears to have benefits during periods of rising interest rates. In addition, our research also showed that interest rate hedging can also protect against possible surges of volatility caused by shifting expectations about interest rate levels.

We think it’s a strategy worth considering.

Investors should be aware that past performance is not an indicator of future results.