LQDH - LQDH: A Hedge For The Fed Not Pivoting

2024-01-04 14:54:07 ET

Summary

• Bond funds that hedge interest rate risk have performed better than those that don't in recent years.
• The iShares Interest Rate Hedged Corporate Bond ETF is a cost-effective option for investors seeking interest rate hedged exposure to investment-grade corporate bonds.
• The LQDH ETF offers a unique blend of features, including investment-grade corporate bond exposure with interest rate hedging, setting it apart from similar ETFs.

Not all funds are created equal. As a matter of fact, those bond funds that hedged interest rate risk did extraordinarily better than those that didn't over the last several years. Is it worth considering hedging bonds again? Maybe - especially if the Fed ISN'T done with rate hikes. That's why the iShares Interest Rate Hedged Corporate Bond ETF ( LQDH ) is worth focusing on.

LQDH is an exchange-traded fund, or ETF, managed by BlackRock (BLK) that primarily invests in investment-grade corporate bonds with the added feature of an interest rate hedge. This unique combination allows the fund to mitigate the potential negative impact of rising interest rates on bond valuations. As a result, the fund's effective duration is near zero, making it less sensitive to changes in interest rates than many other bond funds.

The fund's net expense ratio stands at 0.24%, making it a cost-effective option for investors seeking interest rate hedged exposure to investment-grade corporate bonds. The fund primarily invests in the iShares iBoxx $ Investment Grade Corporate Bond ETF ( LQD ), further supplemented with a portfolio of interest rate swaps to hedge out interest rate risk.

LQD is one of the largest and most well-recognized investment-grade corporate bond ETFs in the market. It serves as an industry benchmark and offers broad exposure to the U.S. dollar-denominated investment-grade corporate bond market. The fund is well-diversified, holding over 2,600 securities from all relevant sectors.

Interest rate swaps are derivative contracts that LQDH uses to hedge against interest rate risk. These contracts provide gains when short-term interest rates rise and losses when they fall. The use of these swaps allows the fund to maintain a near-zero duration, effectively eliminating interest rate risk from the fund's performance.

The hedging resulted in meaningful outperformance relative to LQD.

Peer Comparison

When compared with similar ETFs, such as the Invesco Variable Rate Investment Grade ETF ( VRIG ) and the WisdomTree Interest Rate Hedged U.S. Aggregate Bond Fund ( AGZD ), LQDH offers a unique blend of features. Its combination of investment-grade corporate bond exposure with interest rate hedging sets it apart from its peers. While VRIG also provides exposure to floating rate investment-grade bonds, it does not include an interest rate hedge. On the other hand, AGZD, which does include a hedge, focuses on U.S. aggregate bonds rather than corporate bonds.

Pros and Cons of Investing in LQDH

Pros

1. Interest Rate Hedge : LQDH's use of interest rate swaps to hedge against interest rate risk is a significant advantage. This feature can provide protection against losses during periods of rising interest rates.

2. Investment-Grade Exposure : The fund's primary investment in investment-grade corporate bonds offers a degree of security and stability, as these bonds are issued by financially stable and creditworthy institutions.

3. Diversification : The broad-based nature of the underlying LQD fund offers investors diversified exposure across a wide range of sectors and individual bond issuers.

Cons

1. Credit Risk : Despite the investment-grade status of the bonds in the fund's portfolio, there is still some level of credit risk. This risk could be heightened during periods of economic downturn.

2. Dependence on Underlying Fund : Since LQDH primarily invests in LQD, its performance is heavily dependent on the performance of this underlying fund.

Conclusion: To Invest or Not to Invest

The iShares Interest Rate Hedged Corporate Bond ETF offers a unique investment opportunity for those seeking exposure to investment-grade corporate bonds with a hedge against interest rate risk. Its well-diversified portfolio, solid credit quality, and interest rate hedging mechanism make it a compelling choice for investors. In the current economic climate, where interest rates are fluctuating and credit spreads are historically low, it ultimately boils down to your view of what the Fed does next.

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