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A Simple Way to Fight the Fed Rate Hike

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With the Federal Reserve hinting at its first interest rate hike in almost a decade, investors could adopt alternative fixed-income exchange traded fund strategies to generate yields and hedge rate risks.

On the upcoming webcast, ETF Income Strategies for Today’s Intelligent Advisor, Deutsche Asset & Wealth Management’s Bill Chepolis, managing director and co-head of fixed income for North America, Blair Ridley, director and portfolio manager for municipal bonds, Matt Mark, director of ETF sales, along with Sean Clark, chief investment officer of Clark Capital, discuss the current fixed-income market and potential steps to take as the Federal Reserve looks to hike interest rates.

The labor market has been strengthening alongside an improving economy, which has led many to speculate on a September or December Federal Reserve rate hike.

“I think the point of ‘liftoff’ is close,” Atlanta Fed President Dennis Lockhart said, according to Reuters.

“The economy has made great gains and is approaching an acceptable normal … conditions are no longer extraordinary.”

For fixed-income investors, the higher rates make older debt securities with lower rates less appealing and drag on bond assets and funds. Bond ETF investors can also find out how much rising rates will negatively affect their holdings through an ETF’s effective duration.

For instance, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEArca: HYG)has a 4.17 year duration, so a 1% increase in interest rates would roughly translate to a 4.17% decline in the ETF’s price. Additionally, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYESArca: LQD) shows a 8.06 year duration, so 1% rise in interest rates could mean a 8.06% decline in LQD.

Alternatively, with yields ticking higher, bond investors can utilize rate-hedged bond ETFs to generate income and help better maintain their principle.

For instance, the Deutsche X-trackers Investment Grade Bond – Interest Rate Hedged ETF (NYSEArca: IGIH) and Deutsche X-trackers High Yield Corporate Bond – Interest Rate Hedged ETF(NYSEArca: HYIH) track investment-grade and speculative-grade bonds, respectively, but hedge their positions by shorting Treasury bonds to create portfolios with near zero duration. Consequently, through the short Treasury positions, the Interest Rate Hedged ETFs try to mitigate the negative effects of a rising rate environment and allow an investor to generate attractive yields without worrying about price depreciation.

Nevertheless, potential investors should be aware that these types of zero-duration, hedged bond ETFs may underperform a non-hedged version if rates decline.

Financial advisors who are interested in learning more about ETF income strategies can register for the Wednesday, August 12 webcast here.

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