Hedging Interest Rate Risk with Inverse Bond ETFs
Your Bond Portfolio May Be at Risk
Bond prices have steadily climbed over the past 35 years, but they don't always go up. While not the only factor to affect bond prices, interest rates have possibly the greatest influence. If rates increase, bond prices will typically go down, which could mean potentially significant losses in unprepared bond portfolios. And in the current low-rate environment, bond investors should be wary of interest rate risk.
Duration and the impact of rising rates
To quantify the potential impact of rising rates on your portfolio, it is helpful to look at duration. Duration is an approximate measure of the sensitivity of the value of a bond (or bond portfolio) to a change in interest rates. Higher duration generally means greater sensitivity, and a greater potential for loss when rates rise.
Hedging with an Inverse ETF
Inverse bond ETFs are designed to move in the opposite direction of their fixed-income indexes, rising as they fall and vice versa. These ETFs are also designed to act as if they have a negative duration, which means that adding an inverse bond ETF to a bond portfolio should make the combination act as though it has a lower, less rate-sensitive duration. As a result, if bond prices decline, the hedge should help partially offset losses in the combined portfolio.
ProShares Inverse Bond ETFs
ProShares offers eight inverse bond ETFs that follow five different fixed‑income indexes.
As of 12/30/16
|Fund Name||Ticker||Daily Objective*||Index||Index Modified Duration|
|Short 20+ Year Treasury||TBF||-1x||ICE U.S. Treasury 20+ Year Bond Index||17.665 Years|
|UltraShort 20+ Year Treasury||TBT||-2x||ICE U.S. Treasury 20+ Year Bond Index||17.665 Years|
|UltraPro Short 20+ Year Treasury||TTT||-3x||ICE U.S. Treasury 20+ Year Bond Index||17.665 Years|
|Short 7-10 Year Treasury||TBX||-1x||ICE U.S. Treasury 7-10 Year Bond Index||7.601 Years|
|UltraShort 7-10 Year Treasury||PST||-2x||ICE U.S. Treasury 7-10 Year Bond Index||7.601 Years|
|UltraShort 3-7 Year Treasury||TBZ||-2x||ICE U.S. Treasury 3-7 Year Bond Index||4.45 Years|
|UltraShort TIPS||TPS||-2x||Bloomberg Barclays U.S. Treasury Inflation Protected Securities (TIPS) Index (Series-L)||6.59 Years|
|Short High Yield||SJB||-1x||Markit iBoxx $ Liquid High Yield Index||3.527 Years|
*Before fees and expenses.
Inverse ETFs have one‑day investment objectives, and careful monitoring is essential. Rebalancing may be necessary if you intend to hold these ETFs over time. The effects of compounding may cause the return of an inverse ETF to be greater than or less than the index return times the fund multiple for any holding period greater than one day. Sometimes, the difference can be significant. And remember, a rebalancing strategy may result in additional transaction costs and tax consequences.