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How An iShares ETF Protects Corporate Bonds From Inflation

Investors have fixed-income exchange traded funds dedicated to hedging interest rate risk they can choose from. A new fund features a hedge of its own, but it is an inflation hedge.

The actively managed iShares Inflation Hedged Corporate Bond ETF (CBOE: LQDI) debuted last week. The new fund can be seen as the actively managed inflation-hedged answer to the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSE: LQD), the world's largest corporate bond ETF.

What Happened

The new ETF will achieve its inflation-hedging mandate through the use of inflation swaps, contracts in which the ETF will make fixed-rate payments based on notional amount while receiving floating-rate payments determined from an inflation index,” according to ETF Trends.

LQDI can use other instruments to diminish inflation risk, including Treasury Inflation Protection Securities and interest rate swaps.

Why It's Important

The new ETF's primary holding is the aforementioned LQD with an inflation-hedged overlay. LQDI's weighted average maturity is 11.83 years. The new ETF's effective duration is 7.87 years, below LQD's effective duration of 8.4 years, according to issuer data.

Nearly 84 percent of LQDI's holdings via LQD are rated A or BBB. Over 11 percent of the bonds in the portfolio are rated AAA or AA. BlackRock iShares’ James Mauro and Scott Radell are LQDI's managers.

What's Next

The April reading of the consumer price index showed consumer prices rose 0.2 percent, but that was slightly less than the forecast. Sustained increases in the CPI could result in a following for inflation-hedged strategies such as LQDI.

“A more closely followed measure that strips out food and energy, known as the core CPI, rose a smaller 0.1 percent last month. That was half as much as Wall Street expected,” according to MarketWatch. “The consumer price index has risen 2.5 percent in the past 12 months — the highest rate in 14 months.”

LQDI charges 0.2 percent per year, or $20 on a $10,000 investment, a favorable fee among actively managed ETFs.

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