As the Federal Reserve contemplates a December interest rate hike, investors can turn to inverse Treasury bond exchange traded funds to lower a fixed-income portfolio’s overall duration and hedge against rising rates.
For example, the popular ProShares UltraShort 20+ Year Treasury (NYSEArca: TBT), which has $2.8 billion in assets under management, has been a go-to method for many traders to hedge against falling Treasury bond prices or rising yields – bond prices and yields have an inverse relationship, so rising yields correspond with falling prices.
TBT tries to reflect the inverse -2x or -200% daily performance of the U.S. Barclays U.S. 20+ Year Treasury Bond Index. The leveraged inverse ETF has a 94% correlation to the U.S. Treasury yields, reports Eric Balchunas for Bloomberg.
With the markets anticipating a December rate hike after the strong October jobs number, more investors may turn to TBT to help hedge a fixed-income portfolio against the negative effects of rising rates.
“We think TBT could be our best trade ever, when it occurs,” Sharon Snow, a portfolio manager at Metropolitan Capital Strategies, told Bloomberg. “It takes more than just one Fed fund rate raise to allow this trade to unfold. We are looking at a longer-term time frame when the U.S. economy really takes off, which means three quarters of GDP between 3.3 [percent and] 3.7 percent with an indication of multiple of interest rate increases.”
Along with a tactical bet on rising rates, TBT may be used to depress a bond portfolio’s overall duration – a bond fund’s measure of sensitivity to changes in interest rates. TBT shows a duration of -19 years, so a 1% rise in interest rates could cause the fund to gain roughly 19%. In contrast, the iShares 20+ Year Treasury Bond ETF (NYSEArca: TLT), which tries to reflect the simple long exposure of the Barclays U.S. 20+ Year Treasury Bond Index, has a positive 17.16 year duration, so a 1% rise in rates could mean a 17.16% price decline.
Consequently, adding a little bit of an inverse Treasury bond exposure, such as TBT, could help lower overall interest rate risk without having to go down the yield curve, or sell longer-dated bonds and buy shorter-dated positions.
For the more adventurous, there are aggressive inverse options, such as the Direxion Daily 20-Year Treasury Bear 3X (NYSEArca: TMV), which takes the inverse -3x or -300% daily performance of the NYSE 20 Year Plus Treasury Bond Index.
However, investors who are more conservative may opt to take on something like the ProShares Short 20+ Year Treasury (NYSEArca: TBF), which tracks the inverse -1x or -100% daily performance of the Barclays U.S. 20+ Year Treasury Bond Index.
Potential investors, though, should be aware that these leveraged and inverse ETFs rebalance on a daily basis, so their long-term performances may not perfectly reflect their intended strategies, especially during periods of heightened volatility. [Do You Know How Your Leveraged ETFs Work?]
For more information on the Treasuries market, visit our Treasury bonds category.
Max Chen contributed to this article.