Since fixed-income instruments lose value when interest rates rise, owners of bond exchange-traded fund portfolios have reasons to get worried amid an improving economy and a steadily declining unemployment rate.
Although the Fed seems to be taking a patient approach, many investors are looking for products to hedge their bond portfolios amid the growing chatter of a Fed Funds Rate (FFR) hike before the end of 2015.
The US central bank last raised rates in 2006 and has held the target policy rate (FFR) near zero since the financial crisis hit the economy in late 2008. While there’s no consensus on when the Fed will act, ETF issuers are rushing to meet the rising demand for products that are exclusively designed to offer protection against rising rates.
ETF Managers Capital LLC, a subsidiary of ETF Managers Group, collaborated with New Jersey-based SIT Investment Associates, to roll out the first-of-its-kind ETF that hedges rising interest rates by targeting a constant negative 10-year effective portfolio duration.
The newly launched SIT Rising Rate ETF (RISE) uses futures contracts and options on futures of two–, five–, and 10-year US Treasuries. The fund’s underlying gauge – the so-called Benchmark Portfolio Index, is maintained by SIT Fixed Income Advisors II, LLC.
Duration measures a fixed-income instrument’s sensitivity toward interest rates; negative 10-year duration means RISE would make 10 percent if interest rates rise 1 percent.
The constituents of the benchmark index are based on each Treasury’s duration contribution.
While the expected range for the duration-weighted percentage of the 2-year and 5-year maturity Treasury instruments could vary between 30% and 70%, for 10-year Treasuries it could vary between 5% and 25%. RISE seeks to rebalance its portfolio between maturities when there are material changes to the shape of the yield-curve. The fund’s current portfolio duration is 5 years while current portfolio yield stands at 4%.
RISE seeks to profit in a rising rate environment by using short derivative-contracts by capitalizing on falling bond prices. The new fund is not for market-timers and investors who wish to buffer their portfolio from rate shocks through the buy-and-hold strategy might find it suitable.
Nevertheless, RISE-investors could get punished if the Fed doesn’t raise interest rates this year, a situation witnessed last year when a widely predicted rate-hike never came to pass.
The fund’s annual expense ratio can go up to 1.5 percent through Feb 1, 2016, which means protection from rate hikes doesn’t come cheap.
Disclosure: No holdings