Bond investing has been a painful point for portfolios this year in a rising rate regime as the Federal Reserve aggressively combats persistent high inflation. The Fed responded to June’s 9.1% CPI reading and the strong labor market by raising interest rates 0.75% on Wednesday, reported the WSJ.
“The labor market is extremely tight and inflation is much too high,” Fed Chair Jerome Powell said at a news conference on Wednesday after the announcement.
The Fed has previously indicated that bringing down inflation is its only purpose for now, even if that comes at the cost of economic recession. Already indicators are beginning to show that the economy might be cresting that hill and headed into pullback; both consumer spending and production slowed recently, which the Fed acknowledged in its announcement today.
For bonds, that means continued challenging times ahead.
“Inflation remains the top enemy of fixed-income investors,” wrote KFA Funds in a recent paper.
Signs of economic slowdown are beginning to emerge as the Federal Reserve continues to hike interest rates. For investors who are looking to remain in long-duration Treasuries but are seeking better performance opportunities, the Quadratic Deflation ETF (BNDD) could be a solution.
BNDD is offered by KFA Funds, a KraneShares company, and is a fixed income, ESG-focused, actively managed ETF that seeks to benefit from lower growth, a reduction in the spread between short- and long-term interest rates, deflation, and lower or negative long-term interest rates. Year-to-date BNDD has outperformed long-dated U.S. Treasuries (using the ICE US Treasury 20+ Year Index) by 12.23%.
“This fund has the potential to benefit when 30-year yields decline or when short-term rates rise. These are the sort of changes in interest rates one may expect if the Fed continues hiking or the economic outlook worsens,” KFA wrote.
BNDD seeks to hedge against deflation risk while creating positive returns at times when the U.S. interest rate curve flattens or inverts. It invests in long-duration Treasuries with different maturities either directly or via ETFs that invest in Treasuries. The fund also uses options that are tied to the U.S. interest rate curve and are traded on the OTC market. These include long options, long spreads, and butterflies (an options strategy that uses both bear and bull spreads) in an attempt to limit loss by the fund and enhance returns.
BNDD carries an expense ratio of 0.99% and is actively managed.
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