With the Federal Reserve planning to steadily hike interest rates and normalize its monetary policy ahead, investors should consider a strategic interest-rate hedging exchange traded fund that gives could potentially continue to benefit from higher rates.
Fixed-income investors have utilized long-short bond strategies to diminish rate risk, and the Sit Rising Rate ETF (NYSEArca: RISE) implements such a investment theme by bringing an institutional-level interest rate hedging strategy to everyday investors.
RISE has already increased 5.6% since the presidential election as yields on benchmark 10-year Treasury notes pushed to 2.61%.
The Sit Rising Rate ETF is designed to capitalize on rising rates by holding derivative hedges tied to two-, five- and 10-year U.S. Treasuries.
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 interest rate ETF tries to achieve a negative duration through its short Treasury positions 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.
Consequently, investors may find that the negative duration ETF tries 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% rise in U.S. Treasury yields could translate to about a 10% rise 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 where negative durations reflect an inverse relationship and high durations reflect a significant sensitivity to rate changes.
The underlying portfolio is rebalanced monthly to maintain a negative 10-year average effective duration through short positions in Treasury instruments.
Nevertheless, potential investors should keep in mind that the ETF only has $10.7 million in assets under management with an average daily volume of 8,600 shares, according to Morningstar data, so people should utilize limit orders to better control trades.