Hedging Interest Rate Risk with Inverse Bond ETFs

Your Bond Portfolio May Be at Risk

While not the only factor to affect bond prices, U.S. interest rates have possibly the greatest influence. Bond prices generally move opposite bond yields and interest rates. In the current environment, bond investors should be wary of interest rate risk. An increase in rates could trigger potentially significant losses in unprepared bond portfolios.

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. Bonds with longer-term maturities tend to have higher durations.

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.

The chart below compares the performance of the Bloomberg Barclays U.S. Aggregate Bond Index ("Barclays Agg"), which is made up of investment-grade bonds including government and corporate securities, with a 5% hedge position in ProShares Short 7-10 Year Treasury ETF (-1x daily objective, ticker: TBX) and ProShares UltraShort 7-10 Year Treasury ETF (-2x daily objective, ticker: PST).

Hedging Barclays Agg with TBX and PST: December 29, 2017—February 2, 2018

Source: Bloomberg. This illustration did not implement any rebalances. The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when sold or redeemed, may be worth more or less than the original cost. Shares are bought and sold at market price (not NAV) and are not individually redeemed from the fund. Market price returns are based upon the midpoint of the bid/ask spread at 4:00 p.m. ET (when NAV is normally determined for most funds) and do not represent the returns you would receive if you traded shares at other times. Brokerage commissions will reduce returns. Current performance may be lower or higher than the performance quoted. For both standardized performance and return data current to the most recent month end, see Performance. Index returns are for illustrative purposes only and do not represent fund performance. Index returns do not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest in an index.

ProShares Inverse Bond ETFs

ProShares offers six inverse bond ETFs that follow three different fixed‑income indexes.

As of 2/29/20

*Before fees and expenses.

Considerations When Using Inverse Bond ETFs

• Understand the Yield Curve

ProShares offers inverse bond ETFs benchmarked to different fixed-income indexes, which provide exposure to different parts of the yield curve. It is important for investors to understand where on the yield curve they anticipate rising rates or are exposed to interest rate risk, and to choose the appropriate investment tools.

• Monitor Inverse Investments Daily

Most inverse ETFs aim to provide a multiple of the return of a benchmark for a single day, before fees and expenses. To maintain their investment objectives, inverse funds rebalance their exposure to their underlying benchmarks each day. As a result of daily fund rebalancing, an investor holding an inverse ETF longer term is unlikely to continue to receive the fund's multiple times the benchmark's returns. As long as the ETF is held, compounding can cause the investor's exposure to the underlying benchmark to continue to deviate from the fund's stated objective. Investors using inverse ETFs over periods longer than one day are encouraged to actively monitor their investments, as frequently as daily.

• Consider a Rebalancing Strategy

Rebalancing involves periodically increasing or decreasing an investment in a geared fund to realign its value to the position originally intended. To approximate an inverse bond ETF's multiple for longer than one day, investors may need to rebalance their holdings, which could result in transaction costs and tax consequences. Rebalancing can reduce the negative effects of compounding on performance, but it may reduce the positive effects as well.