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 (NYSEARCA: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 (NYSEARCA: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 (BATS: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.