By investing in international debt or bonds with shorter durations, bond exchange traded fund investors can diversify away from rising rates in the U.S. Specifically, investors can take a look at a relatively new PowerShares ETF that combines both hedging themes.
The PowerShares Global Short Term High Yield Bond Portfolio (PGHY) tries to reflect the performance of the DB Global Short Maturity High-Yield Bond Index, which tracks foreign, short-term, non-investment grade debt denominated in U.S. dollars. PGHY has a 0.35% expense ratio and a 3.79% 30-day SEC yield.
Investors are taking a greater interest in international bonds as a way to diversify away from U.S. government debt, especially as the Federal Reserve thinks about shifting away from its accommodative policy. Yields on benchmark 10-year Treasury notes have topped 2.9%, gaining over 100 basis points since May as investors anticipate Fed "tapering" on the monthly bond purchasing plan.
The PowerShares PGHY ETF's top country allocations include the U.S. 45.1%, Russia 12.3%, Ukraine 9.1%, Brazil 5.1%, Venezuela 4.1%, Finland 3.5%, France 3.4%, Turkey 3.3%, Barbados 2.7% and Canada 2.6%.
Moreover, many are still seeking out high-yield, speculative grade debt options as a way to diversify credit exposure.
"Certain sectors of the bond market react differently to rising rates," according to Morningstar senior fund analyst Cara Esser. "For example, more-credit-sensitive bonds, like high-yield corporates, tend to react less negatively to rising rates than do bonds with more interest-rate risk, such as a U.S. Treasuries."
PGHY's credit quality includes BBB 3%, BB 49%, B 25% and CCC 2%.
Additionally, the PowerShares ETF's low effective duration of 1.55 years helps the fund cope in a rising rate environment. Duration is a measure of a fund's sensitivity to interest rate changes, and high durations will have a greater negative impact on an ETF's performance as interest rates rise.
Over the past month, PGHY's low-duration and international exposure has helped the fund outperform high-yield, junk bond ETFs that focus on the U.S. bond market. PGHY has gained 0.2% over the last month, whereas the SPDR Barclays High Yield Bond (JNK), which has an average duration of 4.49 years and a 5.87% 30-day SEC yield, is down 1.0% over the past month. Additionally, the iShares Global High Yield Corporate Bond ETF (GHYG), which has a 60.9% weighting toward the U.S., an effective duration of 3.92 years and a 5.3% 30-day SEC yield, is 1.1% lower in the past month.
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own JNK.