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Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (NYSEARCA:HYLD), analyzes the results behind hedging high yield.

A strategy that we have seen emerge over the past year within the high yield market has been "hedged high yield." The gist of the strategy here is to go long high yield bonds and short Treasuries. The basic premise is that the strategy will hedge interest rate risk, with any bond pricing decline due to rising rates being offset with the short in Treasuries. At face value this makes sense, as the adage in fixed income is that prices and yields/rates move in opposite directions, so as interest rates increase, prices decline. However, the problem is that this really isn't true in the high yield space.

As we have previously noted, high yield bonds have actually performed very well when interest rates increase and Treasuries and high yield bonds actually have a negative correlation.1

So while a short Treasury position may be appropriate to offset your interest rate risk in the investment grade world, where there is a positive correlation with Treasuries, it does not appear appropriate in the high yield space.

Further, we see another big problem with a combined portfolio of being long high yield bonds and short Treasuries: during times of systemic market disruptions we see a "flight to quality" trade, where investors abandon perceived "risky" assets such as high yield bonds and pile into "risk free" Treasuries. So in a situation like this, you would not only be hit on a decline in your high yield bonds as investors sell them, but you would be hit on your short Treasury position as investors flock to these assets and bid up the price of Treasuries. We have seen a slight glimpse of this over the last week on emerging market and economic concerns. So at face value the "hedge" sounds appealing, but it very well may be far from a hedge depending on the market environment.

For more on the high yield market's historical performance during periods of rising rates and the current strategies in place, and their deficiencies, to address a rising rate environment, see our piece "Strategies for Investing in a Rising Rate Environment."

1 Acciavatti, Peter, Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. "2013 High Yield-Annual Review," J.P. Morgan North American High Yield Research, December 23, 2013, p. 296. For historical performance of the high yield market during periods of rising rates, see our piece "Strategies for Investing in a Rising Rate Environment," p. 4-5.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: AdvisorShares is an SEC registered RIA, which advises to actively managed exchange traded funds (Active ETFs). This article was written by Heather Rupp, CFA the portfolio manager of the AdvisorShares Peritus High Yield ETF (HYLD). We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article. This information should not be taken as a solicitation to buy or sell any securities, including AdvisorShares Active ETFs. This information is provided for educational purposes only.

Additional disclosure: To the extent that this content includes references to securities, those references do not constitute an offer or solicitation to buy, sell or hold such security. AdvisorShares is a sponsor of actively managed exchange-traded funds (ETFs) and holds positions in all of its ETFs. This document should not be considered investment advice and the information contained within should not be relied upon in assessing whether or not to invest in any products mentioned. Investment in securities carries a high degree of risk which may result in investors losing all of their invested capital. Please keep in mind that a company’s past financial performance, including the performance of its share price, does not guarantee future results. To learn more about the risks with actively managed ETFs visit our website AdvisorShares.com.

Source: Hedged High Yield: Is It A True Hedge?