Although interest rates remain near historic lows and the Federal Reserve appears to be taking a patient approach to raising rates, but that has not stopped investors from scouring the universe of exchange traded funds for rising rates protection.
ETF issuers are rushing to meet that demand with new products explicitly designed as protection against rising interest. The newly minted Sit Rising Rate ETF (NYSEArca: RISE), courtesy of New Jersey-based Sit Investment Group and ETF Managers Capital, brings institutional-level interest rate hedging to everyday investors.
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.
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. [Fixed Income ETFs for a Rising Rate Environment]
With a negative 10-year duration, the idea is that a 1% rise in U.S. Treasury yields results in about a 10% rise in price. So the price moves nearly 10 times the change in yield. RISE is focused on the 2 and 5-year U.S. Treasury futures with a minor weighting in 10-year future, according to a statement issued by Rise.
RISE “is designed to profit as rates rise by using derivative hedges tied to two- and five-year Treasurys,” reports Katy Burne for the Wall Street Journal.
“The weighting of the Treasury Instruments constituting the Benchmark Portfolio Index will be based on each maturity’s duration contribution. The expected range for the duration weighted percentage of the 2 year and 5 year maturity Treasury Instruments will be from 30% to 70%. The expected range for the duration weighted percentage of the 10 year maturity Treasury Instruments will be from 5% to 25%,” according to Rise.
Negative duration ETFs 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.
RISE charges 0.5% per year.
ETF Trends editorial team contributed to this post.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.