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Coming Soon: Rising Rates ETF

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While a bull market was the name of the game for much of 2013, recent talk from the Federal Reserve has thrown a wrench into the uptrend. Their plan to possibly taper bond purchases as early as this year has sent markets crumbling, and bond yield soaring to new heights.

In fact, 10-year Treasury bonds have seen yields rise by about 90 basis points—from roughly 1.6% to 2.5%-- since the start of May, while rates have also spiked for shorter-term debt as well. This has crushed bond prices across the board causing many to reevaluate their fixed income holdings.

Beyond that though, stocks have also plunged with high-income securities leading the way in terms of losses, including some double digit losses for the past month alone. This has left many investors scrambling to allocate more capital towards sectors that will benefit from a rising rate environment, and away from those that are likely to get crushed in this scenario (see QE Tapering Could Make These Bond ETFs Winners).

Unfortunately, there are few products that look to directly benefit from this trend on the market right now, save for a handful of inverse products that look to give exposure to the opposite performance of certain bond benchmarks. This could soon be changing though, as evidenced by a recent filing by AdvisorShares for a Rising Rates ETF.

This potential new product could help to give investors a fresh option if rates continue to rise across the board. While certain key details were not yet released—such as the expense ratio or launch date—we have highlighted some of the other important points from the recent SEC filing below:

Rising Rate ETF in Focus

The proposed ETF looks to trade under the symbol of HDGB with the name of AdvisorShares Treesdale Rising Rates ETF. So the fund will be sub-advised by Treesdale Partners LLC, a New York-based firm that specializes in risk and asset management.  

The fund looks to generate current income while providing protection in a rising interest rate environment. This looks to be done by taking positions in mortgage-related products with interest-only cash flows, while managing duration with liquid interest rate products (read Forget Interest Rate Risk with These Bond ETFs).

According to the filing, the fund will invest principally in ‘agency interest-only mortgage-backed securities, interest-only swaps and certain other mortgage-related derivative instruments, while maintaining a negative portfolio duration with a generally positive current yield by investing in U.S. Treasury obligations and other liquid rate instruments.’

The mortgage instruments seek to provide the ETF will its negative duration exposure, and thus look to benefit when rates are rising in the marketplace. Overall, the product seeks to have a negative duration range from -5 to -15 years, suggesting a modest level of interest rate risk, though this will be partially offset with long positions in T-Bonds and positive duration fixed income securities.

It is also worth noting that the duration target will be based on high-level macro conditions, as well as relative value across all fixed income markets. Additionally, the fund looks to mitigate some other fixed income risks—like prepayment risk—by diversifying the portfolio. The fund also looks to rebalance Treasury and rate swap hedges daily, while rebalancing its mortgage portfolio on a much less frequent basis.

ETF Competition

This kind of negative duration could make this proposed fund a great addition for investors worried about rising rates. This is particularly true given the lack of additional options in the market to play this trend (also read 3 Sector ETFs to Profit from Rising Rates).

With that being said, there are a few ETFs that could give this potential new fund some competition, specifically in the inverse bond ETF market. ETFs in this corner of the fixed income world also benefit when bond prices are sliding, making them interesting plays in this kind of market.

Some of the most popular funds in this segment include the unleveraged long term inverse bond ETF (TBF - Free Report) , along with its leveraged inverse counterparts (TBT - Free Report) and (TMV - Free Report) , which offer up, respectively, -200% and -300% daily resetting exposure.

This trio of ETFs, along with several others on the curve, have attracted more than a handful of investors, with the three mentioned above having (combined) accumulated close to $6 billion in total assets alone.  Given this, it may be difficult to break into this space, especially for an active product.

The real test for the proposed fund will likely be the expense ratio. Active funds are usually more expensive than their passive counterparts, and some of the strategies involved with this product could add to total costs as well (also see Protect Against Rising Rates with Floating Rate ETFs).

Still, the desire for products that can successfully navigate a rising rate environment looks to be immense, especially given the current Fed focus. So if this trend continues, and if the proposed fund can successfully navigate SEC hurdles, AdvisorShares could have another active winner on its hands with this timely, and in-focus, product.

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