How A Negative-Duration Bond ETF Works

January 14, 2014

Institutional tool for managing interest-rate risk comes to retail investors.

WisdomTree recently launched the market’s first negative-duration bond ETF—a fund that should offer investors broad exposure to one of the market’s most popular broad U.S. bond benchmarks while offering protection from rising interest rates.

The WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (AGND) is essentially a long/short portfolio that serves up long exposure to the Barclays U.S. Aggregate Bond Index while seeking to manage interest-rate risk through the use of short positions in U.S. Treasury futures, according to the fund’s prospectus.

The idea of shorting Treasurys as a way of minimizing exposure to interest-rate risk has long been used in the institutional space, but AGND is the first example of an ETF issuer bringing a popular institutional-caliber solution to the ETF market.

The move speaks volumes to the pressure issuers are facing to meet investor demand for alternative ways of capturing yield in the current rising-rate environment. Now that the Federal Reserve said it will begin tapering its massive bond-buying program this month, more and more investors expect rates to move higher. Many have, in fact, projected yields on 10-year Treasurys will hit 3.5 percent by the end of this year, up from about 2.9 percent now.

In 2013, there was clear demand for shorter-duration bond funds exactly for that reason. More than $23 billion flowed into 0- to five-year duration fixed-income ETFs last year—to combat interest-rate sensitivity. As yields rise, bond prices decline.

How Negative-Duration Bond Portfolios Work

In the bond market, there’s a general rule of thumb that says for every 1 percent of interest-rate increase, the value of a bond portfolio will drop by the amount of its duration.

That’s to say that if an investor has a bond portfolio with a five-year duration and interest rates go up 100 basis points, that investor should expect a 5 percent decline in the value of the bond portfolio, WisdomTree’s head fixed-income strategist Rick Harper says.

What AGND does is invest in the same bonds comprising the Barclays Aggregate index—which currently has a duration of about 5.5 years—but it also shorts Treasury futures to a targeted total duration exposure of approximately negative five years.


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