Rising interest rates are creating a challenging time for bonds and have many advisors looking for income solutions for their traditional portfolios. Simplify Asset Management’s Eric McArdle, SVP of advisor solutions, and Harley S. Bassman, Convexity Maven and managing partner, discuss alternative and fixed income strategies in a recent webcast moderated by Lara Crigger, managing editor of ETF Trends.
Advisors overwhelmingly reported that they were concerned about the combination of rising interest rate risk, low forward-looking return expectations, and decreasing reliability of anti-correlative benefits during equity market sell-offs within bond allocations.
Bassman opens by discussing inflation and how it is typically used to combat debt, but this most recent cycle of increasing the money supply to address old debt created inflation in unexpected areas.
“A lot of people out there say inflation didn’t happen, it didn’t work. It did happen, it just didn’t happen where they wanted it. The idea was to have inflation in wages, middle-class wages,” explains Bassman. “Unfortunately, we got it in assets; stocks, bonds, gold, cars, jewelry, everything you could think of went up in price.”
Bassman goes on to discuss that the inflation seen in the 1970s was driven largely by demographics and the Baby Boomer generation’s participation in the economy and labor force, which created greater demand for a time than supply. Bassman expects this trend to happen again in the next five years as Millennials marry, buy houses, and have children and the Baby Boomer generation retires.
Stocks and bonds have historically moved in negative correlation to each other, but when inflation rises high enough, the two move in tandem, which can create huge problems for advisors and investors. It’s something that happened in March, 2020, as well as December, 2018, when stocks and bonds both fell in tandem, and Bassman believes it could happen again if interest rates rise above 3.5–4%.
“The yield curve is the best predictor of a recession,” Bassman says. The current flattening of the yield curve is somewhat concerning because where it’s been driven by the Fed front-loading and raising interest rates in the past, it’s happening now before the Fed has raised rates at all. Bassman believes that once the bond tapering ends, it will give a more accurate snapshot of the actual reality of the economy and markets outside of interest rate increases.
TYA and PFIX in Rising Rate Environments
“The 60/40 portfolio, using TYA (the Simplify Risk Parity Treasury ETF) to get your 40 is not that bad of an idea,” Bassman says. “A month ago, I wouldn’t have said that at all, but the way the curve is trading, it’s looking like a good idea. The reason why you want to buy TYA as opposed to a 30-year Treasury or 30-year bond to get that duration is that from that seven-year point, it will roll down the curve and it will perform better.”
The Simplify Interest Rate Hedge ETF (PFIX) is an excellent option for advisors and investors who are focused on interest rate increases and is essentially a long-term option in the form of an ETF, according to Bassman. This type of strategy previously had only been available to corporations and hedge funds, but it is now available for individual investors and essentially can act as an insurance policy for a portfolio in the case of bonds and stocks falling.
PFIX is essentially a long-dated put option that you can put into your portfolio alongside fixed income duration assets or different asset classes, explains McArdle. Simplify recommends a 5% allocation to this fund as a baseline, but it depends on the duration exposure, risk, and portfolio composition.
“TYA is a little bit of a different beast, and what we are trying to do here is tackle really the high opportunity cost of owning Treasury bonds,” says McArdle. “TYA takes the approach that we are trying to get capital efficiency out of our Treasury exposure, so rather than buying a 10-year Treasury, we will lever up 10-year Treasury futures.”
TYA uses 10-year Treasury futures that are reset on a quarterly basis and does not have a daily leverage component.
Financial advisors who are interested in learning more about how to invest differently within bonds can watch the webcast here on demand.
For more news, information, and strategy, visit ETF Trends.