Hedging your portfolio: Simple strategies and outstanding benefits (Part 3 of 4)
Though investors resort to Treasuries when they’re looking for safe investments, since they’re guaranteed by the Federal Reserve, you may want to lock in a minimum return on the investment.
Treasury yields have been at an all-time low, sending bonds prices soaring. However, now, with the Fed tapering its massive bond-buying program, we can expect Treasury bond prices to fall with rising interest rates. So, an investor’s real returns will be negatively affected. But there are still ways you can lock in your returns.
With rising interest rates, it only makes sense to lock in your returns as early as possible. Holders of long-term Treasury bonds may want to switch to shorter-term Treasuries in order to prevent erosion in bond value.
Duration is a measure of a bond’s sensitivity to interest rate changes. Also, it’s directly related to a bond’s maturity. The shorter the maturity, the lower the duration and the lower the sensitivity. So, in a rising interest rate environment, Treasury investors should try to move their funds from longer-term to shorter-term Treasury securities.
The iShares 3–7 Year Treasury Bond ETF (IEI)—a Treasury ETF with an average maturity of 4.67 years and an effective duration of 4.45 years—is less sensitive to interest rate changes than Treasuries with longer maturities.
The chart above shows how the IEI is less volatile than the iShares 20+ Year Treasury Bond ETF (or TLT), which is another Treasury ETF—but with an average maturity of 26.84 years and an effective duration of 16.24 years.
Inverse Treasury ETFs
Inverse Treasury ETFs, such as the ProShares Short 20+ Year Treasury (TBF) and the iPath US Treasury 10-year Bear ETN (DTYS), are designed to move up in price along with interest rates. Bonds will fall in price as interest rates rise, but inverse bond funds like TBF will rise when bonds fall. The ProShares Short S&P 500 and the ProShares UltraShort S&P 500 are popular examples. You can also refer to the chart in Part 1 of this series to see the inverse price movements between the Treasury fund TLT and the inverse Treasury fund TBF.
The good news is that most inverse Treasury ETFs have low expense ratios. For example, the Treasury Floating Rate Bond ETF (TFLO) has no expense ratio. For other non-Treasury funds like the Active Bear ETF (HDGE), an inverse equities fund with holdings in International Business Machines Corp. (IBM) and Caterpillar Inc. (CAT), expense ratios go as high as 1.85%.
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