“By incorporating Treasurys futures [as in AGND], you’d have something like 80 percent invested in the five-year duration portfolio, and the remaining 20 percent in the negative five,” Harper said. “By simple math, your overall portfolio interest-rate risk is now equivalent to that of a three-year Treasury, so for the same 100 percent interest-rate rise, you now expect only a 3 percent decline.”
Again, the longer-dated the bond portfolio is, the more sensitive it will be to that interest-rate hike, which is why so many investors have been shorting the duration of their bond allocations in recent months.
What’s also interesting about AGND is that, unlike most of WisdomTree’s other ETFs, this one is linked to the Barclays Aggregate index rather than to an in-house benchmark.
The reason for that is so that investors who already own exposure to the Barclays Aggregate index can supplement, or hedge the interest rate associated with that position rather than have to move into a completely new strategy, WisdomTree’s Chief Investment Strategist Luciano Siracusano said.
“A lot of people already own the Agg, it’s a core position in their portfolio and they have embedded capital gains on it,” Siracusano told IndexUniverse. “But the Agg right now has a duration of about 5 ½ years, and the interest is only 2.4 percent. It’s one of the worst trade-offs it has ever had—very long duration, very little yield, and you’re in a rising-rate environment.”
As an example, if an investor were to invest $80 in a fund tracking the Barclays Aggregate, and $20 in AGND, “that would reduce their interest-rate risk from a five-year duration to a three-year duration, which is essentially a 40 percent reduction in overall interest-rate risk for a 20 percent capital commitment,” Harper added.
There’s no question that shortening the duration of a bond portfolio, while it minimizes interest-rate risk, also trims the potential yield. AGND certainly has a negative drag on portfolio yields, but the interest from the long position should generate enough to offset that, Harper says.
“Think of it as providing insurance to your bond portfolio; there’s a cost to that protection, which is the interest-rate drag,” Harper explained.