ETFs To Hedge US Interest Rate Risk

August 10, 2015

If you’ve been waiting for an actual rate hike to take place before adjusting your bond portfolio, you might have already been losing money.

The Fed has yet to take action on raising the fed funds rate, but other interest rates such as Treasury yields have already been rising—to the detriment of many bond investors.

In a market commentary Friday, ProShares reminded us of the important distinction between the fed funds rate—the rate banks use among themselves to lend and borrow—and interest rates that are not determined by the Fed, but by “market forces.”

Uncorrelated Movements
At the end of the day, these two types of rates can have completely uncorrelated movements, which was the case in the April-to-June period ProShares singled out. Then, as the fed funds rate sat quietly, 10-year Treasury yields rose more than 60 basis points.

For an ETF investor with exposure to 10-year and longer-dated debt through funds such as the iShares 7-10 Year Treasury Bond ETF (IEF | A-51) and the iShares 20+ Year Treasury Bond ETF (TLT | A-85), this period of quiet in the fed funds rate looked like this for their portfolios:

TLT lost more than 11 percent in three months, and IEF bled 3.5 percent.

“It’s not uncommon for interest rates and the Fed Funds rate to move in the opposite directions,” ProShares said in the commentary. “Investors waiting for the Fed might have waited too long and missed the boat.”

When rates rise, bond prices tend to fall, and the longer-duration debt you own, the more sensitive your exposure is to those changes.

“So, what’s a concerned bond investors to do? Focus on what’s in front of you—the market,” ProShares said. In other words, don’t wait for the Fed.

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