Using Bond ETFs To Hedge Against Fed Hikes

April 27, 2016 Based on your outlook, how do you think fixed-income investors should be positioning themselves?

Doty: It pays to protect right now. There's a lot of volatility, and that volatility is going to continue.

The Fed had been suppressing volatility by being so stimulative and printing so much money with its QE programs. All that is gone. The market has to stand on its own two feet now.

We manage $14 billion in stocks and bonds. My group is responsible for $6.5 billion of taxable bonds. Our clients are used to their bonds being the safe portion of their portfolio or the anchor of their portfolio. But in the past six months, it's been anything but that, and they're understandably not comfortable with the volatility.

So what we've been doing is implementing strategies to act as shock absorbers against all that volatility. That's where the Sit Rising Rate ETF (RISE) is a very useful tool.

RISE shorts two- and five-year Treasurys primarily because they’re the most sensitive to a change in Fed policy. With just a 10-15% allocation, you can greatly reduce interest-rate risk while maintaining the income off your bond portfolio. It's the least disruptive way to hedge your portfolio.

It's tough for me to sit there and watch people shorten duration by going into, for example, a short-duration government fund. First of all, you give up tons of yield; you probably are paying capital gains tax; and you're right in the bull's eye part of the curve that's going to get hurt if the Fed does raise rates.

I'd rather people keep something like the iShares National Muni Bond ETF (MUB | B-79) or the SPDR DoubleLine Total Return Tactical ETF (TOTL | C). Combine it with the iShares TIPS Bond ETF (TIP | A-99), the iShares Floating Rate Bond ETF (FLOT | B-98) and RISE.

Then you end up with a two-year-duration bond portfolio that still has some decent income—either tax exempt or taxable, whatever your preference is. You get a little inflation protection from TIP and a little Fed protection in RISE.

Rather than using the money market for some of your cash, use FLOT, and if short rates go up, your yield goes up with them.

I like those kinds of ideas rather than just going into short duration.

Contact Sumit Roy at [email protected].

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