Now that U.S. markets try to wean itself off quantitative easing and prepares for rate risks, bond investors can utilize long-short exchange traded funds to navigate the fixed-income market while mitigating the negative effects of rising rates.
On the upcoming webcast, Fixed Income Strategies at Taper’s End – Are You Really Prepared?, Rick Harper, WisdomTree’s Head of Fixed Income & Currency, warns investors about the potential after effects of a tighter monetary policy and an end to the Federal Reserve’s bond purchasing program.
One way to diminish interest rate risk is through taking an institutional approach. Specifically, fixed-income investors can utilize long-short bond strategies to diminish rate risk.
For instance, investors can take a look at the WisdomTree Barclays U.S. Aggregate Bond Zero Duration Fund (NYSEArca: AGZD), WisdomTree Barclays U.S. Aggregate Bond Negative Duration Fund (NYSEArca: AGND), WisdomTree BofA Merrill Lynch High Yield Bond Zero Duration Fund (NYSEArca: HYZD) and WisdomTree BofA Merrill Lynch High Yield Bond Negative Duration Fund (NYSEArca: HYND).
These new types of zero duration or negative duration ETFs hold long-term bonds, but they will short Treasuries or Treasury futures contracts to hedge against potential losses if interest rates rise – bond prices have an inverse relationship to interest rates, so rising rates corresponds with falling bond prices.
With a near zero duration, changes in interest rates would a negligible effect on the ETFs. For example, the AGZD has a 0.12 year duration and HYZD has a -0.34 year duration, which could show that a 1% increase in interest rates would roughly translate into a 0.12% decline in AGZD’s price and a 0.34% gain in HYZD.
Negative duration ETFs, on the other hand, try to profit off a rising rate environment by heavily using short contracts to capitalize on falling bond prices if rates do rise. However, due to the more aggressive nature of this strategy, these types of ETFs will underperform if rates fall.
AGND shows a negative 5.02 year duration while HYND has a negative 7.44 year duration. Consequently, a 1% rise in interest rates could generate a 5.02% gain in AGND and a 7.44% increase in HYND. However, a falling rate would negatively affect the ETFs.
Morever, the diverging central bank policies, notably between the Fed’s tightening stance and the European Central Bank and Bank of Japan’s loosening policies, could signal a stronger dollar currency. [Hedged-Europe ETFs to Capture ECB $1.2T Stimulus Growth]
Currency traders can take a look at the actively managed WisdomTree Bloomberg U.S. Dollar Bullish Fund (NYSEArca: USDU) to capture any further strength in the USD. USDU, though, tracks the USD against a broader basket of developed and emerging market currencies – the euro, yen, Canadian dollar, Mexican peso, pound sterling, Australian dollar, Swiss franc, South Korean won, Chinese yuan and Brazilian real. [Overseas Deflation, Currency Wars to Support USD ETF]
Financial advisors who are interested in learning more about bond strategies for the changing fixed-income environment can register for the Wednesday, November 11 webcast here.