Hedged Corporate Bonds - Not a good deal over the last year

A corporate bond has two components, an underlying Treasury exposure with risk premium or spread associated with the default risk of the issuing company. Your return will be associated with the performance of each of those pieces. If rates do not change but spreads tighten, the investor will receive a total return gain. The added return will be the spread yield plus the spread tightening times the duration of the bond. 

Investors can buy a corporate and high yield bond index (LQD and HYG). They can also buy LQDH and HYGH which is the hedged version of the same index. The hedge reduces the underlying duration or Treasury interest risk in the portfolio. An investor is only holding the corporate risk exposure. That change in risk can have a significant impact on performance.

In the last year, grabbing for yield has been good for corporate and high yield investors, but the gain has come from the interest rate duration exposure and not from the added yield of holding corporate risk. Over the last year, investors only got 20% of their return from corporate bond spreads and less than 50% from high yield spreads. Buying yield is a two-part decision. Sometimes you want to buy the premia and other times you want to have the duration.