Election Boosts Negative Duration Bond ETFs

A steepening Treasury curve and prospects for higher interest rates could be what negative-duration bond ETFs have been needing for traction.

The Treasury yield curve has been steepening since the election, with 10-year yields hitting one-year highs in recent days amid a bond sell-off. In that environment, and in the face of a potential interest rate hike next month, negative-duration bond ETFs could come into the spotlight as investors look to profit from the rate rise.

There are only two funds in this segment, and they haven’t really captured investor attention:

• The WisdomTree Barclays U.S. Aggregate Bond Negative Duration ETF (AGND) tracks a long/short net -5 duration bond index that's long U.S. investment-grade issues and short Treasury futures. AGND has $13 million in assets under management. The fund carries an expense ratio of 0.28%, and it trades with an average spread of 0.55%, putting total cost of ownership at around $83 per $10,000 invested.
• The WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration ETF (HYND) tracks a long/short net -7 duration bond index that's long U.S. high-yield issues and short Treasury futures. The fund has only $8 million in assets. It has an expense ratio of 0.48%, and trades with an average spread of 1.71%, meaning the total cost to own and trade this ETF is about $219 per $10,000 invested.

Both of these ETFs track a traditional bond index, and the funds also short Treasury futures to hedge duration risk.

Throughout the rally in the Treasurys, a position in AGND—which has a negative duration of about -5.3 years—didn’t exactly pay off. But in the past three weeks, as bonds began to sell off following the U.S. presidential election, it’s clear to see the change in trend, as the chart below shows: 

In the case of HYND, which has a negative duration of about -6.8 years, the long position is akin to that of the iShares 0-5 Year High Yield Corporate Bond ETF (SHYG), with a short Treasury position. HYND, too, has seen a performance spike in recent weeks: 

Charts courtesy of StockCharts.com

In a recent blog, WisdomTree, the issuer behind these funds, argued that negative-duration bond ETFs are handy for investors wanting to profit from rising rates. The firm also said that in this era of ultra-low yields, investors may have gotten “complacent in managing interest rate risk.” Yes, WisdomTree is speaking its book as an issuer, but the firm could very well have a point.

Dave Nadig, CEO of ETF.com and a well-known ETF expert, recently suggested as much, noting that “Duration hedging hasn’t yet had its ‘hedge the yen’ moment when investors discovered the power of currency hedging en masse, but like currency-hedged ETFs, duration-hedged ETFs may start finding a place not necessarily as core holdings, but as finely honed tools for tweaking duration exposure in a broader bond-portfolio context.”

Contact Cinthia Murphy at [email protected]