With yields rising and many anticipating an imminent Federal Reserve interest rate hike, bond investors can consider an alternative, strategic interest-rate-hedging exchange traded fund strategy to diminish the negative effects of the Fed’s expected rate normalization.
The Sit Rising Rate ETF (NYSEArca: RISE) brings an institutional-level interest rate hedging strategy to everyday investors. The fund has already increased over 5% since the presidential election as yields on benchmark 10-year Treasury notes now hovering around 2.39%.
RISE is a “strategic interest rate hedging tool that gives investors the opportunity to benefit from the rise in the interest rates of U.S. Treasury notes,” according to Sit Investment Group.
Specifically, RISE is designed to capitalize on rising rates by utilizing derivatives hedges tied to two-, five- and 10-year U.S. Treasuries.
[related_stories]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%. Additionally, the expected range for the duration weighted percentage of the 10 year maturity Treasury Instruments will be from 5% to 25%, according to Rise.
The underlying portfolio is rebalanced monthly to maintain a negative 10-year average effective duration through short positions in Treasury instruments.
Negative duration bond 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.
With a negative 10-year duration, investors may find that a 1% increase in U.S. Treasury yields results in about a 10% return in RISE’s price. So the price moves nearly 10 times the change in yield. Duration is a measure of a bond funds sensitivity to changes in interest rates, so a large effective duration reflects a greater sensitivity in the bond fund’s price to changes in rates.
For more information on the fixed-income market, visit our bond ETFs category.