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Prepare for Rising Rates with These Inverse & Hedged Bond ETFs

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The speculation about the Fed rate hike is back on the table, following Fed Bank of Boston President Eric Rosengren’s comments on the possibility of sooner-than-expected Fed policy tightening.

According to Rosengren, “"if we want to ensure that we remain at full employment, gradual tightening is likely to be appropriate”. He also noted that “a reasonable case can be made for continuing to pursue a gradual normalization of monetary policy.” If this was not enough, Rosengren expressed confidence in labor market strength and the U.S. economic growth prospects.

He is normally known for his dovish comments and this sudden change to hawkishness weighed on stocks and pushed up bond yields on September 9. The U.S. 10-year Treasury yield rose 13 bps in just two days to 1.67% on September 9, while yield on the six-month U.S. Treasury yield grew 2 bps to 0.51% during the same timeframe.

This steepening of the yield curve indicates that investors still have faith in economic growth despite the dreary job, manufacturing and service sector data for the month of August. In fact, these unspringing data points put off increased speculation over a September hike that emerged last month.

Talks that the Bank of Japan is mulling over means to steepen the yield curve of the Japanese bonds, along with the hearsay that the global central banks have fewer options to offer further stimuli were also behind the rise in Tresury yields.

Investors should note that the fixed-income investing had enjoyed a great show so far this year, especially in the longer part of the yield curve. However, the prospect of rising rates and risks to capital gains of the bond holdings have left investors jittery about the safety of their bond portfolios.

Notably, PIMCO 25+ Year Zero Coupon U.S. Treasury Index Exchange-Traded Fund ZROZ, which has added 21.6% in the year-to-date frame (as of September 9, 2016), lost over 2.5% on September 9. iShares 20+ Year Treasury Bond ETF TLT is up over 13% so far this year (as of September 9, 2016) but lost over 1.6% on September 9.

Given the situation, many investors are definitely pulling their money out of the bond market. At a time like this when investors are extremely cautious about rising rate risks and stock market volatility, investments in U.S. bonds with significant protection against potential rising rates can be good bets. Some opportunistic investors could capitalize on this backdrop in the form of inverse and interest rate-hedged bond ETFs too (read: Two Interest Rate Hedged ETF Launches from iShares).

Barclays Inverse US Treasury Aggregate ETN TAPR

The note provides investors a unique strategy to hedge against or benefit from the rising U.S. dollar interest rates by tracking the Barclays Inverse US Treasury Futures Aggregate Index. This benchmark employs a strategy, which follows the sum of the returns of the periodically rebalanced short positions in equal face values of each of the 2-year, 5-year, 10-year, long-bond and ultra-long U.S. Treasury futures contracts. TAPR added about 6.9% on September 9, 2016 (read: Interest Rate Speculation: A Boon for TAPR ETF).

Sit Rising Rate ETF RISE

The ETF looks to track the performance of a portfolio comprising exchange traded futures contracts and options on futures on 2, 5 and 10-year U.S. Treasury securities weighted to attain the targeted negative 10-year average effective portfolio duration. The fund advanced about 0.2% on September 2, 2016 (read: Bond ETFs to Play if Fed Hikes in June).

WisdomTree Barclays U.S. Aggregate Bond Zero Duration Fund AGZD

Rising rates result in increasing losses for bonds since bond price and yields are inversely related to each other. As a result, zero or negative duration bonds are less vulnerable and better hedges to rising rates.

The fund looks to track the Barclays Rate Hedged U.S. Aggregate Bond Index, Zero Duration which comprises of a long & short portfolio. The long portfolio replicates Barclays US Aggregate Bond Index comprising of US Government related bonds, corporate bonds, mortgage-backed passthrough securities. The short portfolio holds short position in US Treasuries corresponds to duration exposure matching the long portfolio, with total duration of approximately 0yrs. AGZD was up about 0.2% on September 9, 2016 (read: Rising Interest Rates Are Great News for These Bond ETFs).

WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund

The fund looks to track the Barclays Rate Hedged U.S. Aggregate Bond Index, Negative Five Duration. Its long portfolio mirrors the Barclays US Aggregate Bond Index comprising US Treasuries, US Government bonds, corporate bonds and etc. The short portfolio holds short positions in US Treasuries corresponding to duration exposure exceeding the long portfolio, with duration of about negative 5 years. The fund added 0.6% on September 9, 2016.

Bottom Line
As a caveat, investors should note that these inverse products are suitable only for short-term traders as these are rebalanced on a daily basis (see: all the Inverse Bond ETFs here).
Still, for ETF investors who are bearish on the bond market in the near term, any of the above products could make an interesting choice.
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