Fed Rate Hike: A Bond ETF Bonanza for Active Investing?

Attention active equity ETF investors: You now have permission to use bond ETFs similar to how you’re used to using their equity cousins.  

That’s after the Federal Reserve today lifted interest rates to a 22-year high with its latest 25 basis point increase. 

If you’re an advisor or investor who farms out the day-to-day investment selection by owning exchange-traded funds that actively buy and sell for you, a la what mutual funds have done historically (ETFs are now taking over in popularity), your investment life just became more interesting.  

The reason this is such a hot topic despite many in the industry not making it a priority, is because advisors and their clients crave flexibility. In other words, the wider the opportunity set, the more choices to try to make money, earn income and especially preserve capital. 

For ETF investors and financial advisors looking to pounce on potential opportunities, the good news is that there’s time. That’s because we’re at the start of a “see how what we did impacts the economy” period, and conclusions won’t be revealed immediately.  

Active Bond ETF Management 

So, advisors can take a breath, hunker down and look at how to add a new, differentiating dimension to their practice: active bond management using ETFs. Here are a few to help initiate the research process. 

There are a growing number of ETFs that can potentially address this opportunity. At the same time, strategies that the Fed’s moves are spinning out for advisors continues to multiply. While those different paths are vast, here are a few funds to start the deeper dive. 

The Quadratic Interest Rate Volatility and Inflation Hedge ETF (IVOL) may have been a bit ahead of its time. It debuted just over four years ago and has had a negative total return since inception. But as noted above, conditions are now changing for the first time in at least a decade, so strong track records might be more of a negative factor, given the nature of the opportunity. 

The Invesco 1-30 Year Laddered Treasury ETF (PLW) allows investors to play in the middle so to speak, by owning Treasuries across the issuance curve. It yields about 3.9% currently, but should longer rates rise and shorter-term rates fall (“curve steepening”), this $657 million ETF may be able to keep pace. 

RATE ETF for New Fed Phase 

Finally, while the following may be too small an ETF for some investors, it has the right idea. The Global X Interest Rate Hedge ETF (RATE) is relatively new (debuted just over a year ago), has $3.2 million and has generated a 15% total return the past 12 months.  

Apparently, few have noticed. That might be due to the somewhat complex nature of the strategy. It tends to own about 85% of assets in Treasury securities (bonds or futures) as collateral to use the rest of its capital to own “swaptions,” with the goal of moving opposite of the price of U.S. Treasury bonds, and with a high correlation to long-term interest rate movements.  

As noted above, the Fed has entered a new phase, involving less focus on how much and when to raise rates, and more attention to how the economy will ultimately react to what’s already occurred. Now that the fed funds rate is sitting at 22-year highs, things may get interesting—and profitable—for forward-thinking, research-oriented financial advisors.