Using ETFs To Hedge Against Rising Rates

September 29, 2016

Long/Short Bond Funds

Another group of ETFs attempts to reduce duration by simultaneously holding long and short positions in bonds. The WisdomTree Barclays US Aggregate Bond Negative Duration Fund (AGND) holds the bonds in the Barclays Aggregate Bond Index and a short position in Treasurys at the same time. The result is a portfolio of bonds with a duration of negative 5.

Once again, AGND could be used as a stand-alone product to speculate on interest rates or combined with, say, another position in the iShares Core U.S. Aggregate Bond ETF (AGG) (which incidentally has a duration of positive 5) to reduce an investor's interest rate risk.

ETFs that use a similar strategy as AGND’s include the VanEck Vectors Treasury-Hedged High Yield Bond ETF (THHY) and the ProShares High Yield-Interest Rate Hedged ETF (HYHG), which short Treasurys to hedge a portfolio of high-yield bonds. Both target a duration of zero.

YTD Returns For AGND, THHY, HYHG, AGG, HYG

 

Floaters

For investors who want to do away completely with interest rate risk, a straightforward solution floating-rate ETFs. The iShares Floating Rate Bond ETF (FLOT) holds a basket of bonds with maturities of five years or less. As floating rate notes, the interest rates on these securities resets periodically based on market rates; so if rates increase, the payout increases too (the downside is that rates on floaters will tend to be lower to account for the smaller risk).

Floaters are attractive compared to fixed-rate bonds when rates are expected to increase, but not as attractive when rates are expected to decline.

The PowerShares Senior Loan Portfolio (BKLN) is another type of floating-rate ETF. It tracks an index of the 100 largest bank loans with floating rate coupons. The fund has little interest rate risk, but relatively high credit risk due to its below-investment-grade portfolio.

YTD Returns For FLOT, BKLN, SLQD, HYG

 

Contact Sumit Roy at [email protected].

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